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Dollar and S&P 500 Breaks Must Abide the FOMC Decision This Week

Dollar and S&P 500 Breaks Must Abide the FOMC Decision This Week

John Kicklighter, Chief Strategist

S&P 500, VIX, Dollar, USDCAD and GBPUSD Talking Points:

  • A late break from the Dollar via EURUSD and USDCAD has drawn attention but follow through ahead of the Fed is a tall order
  • Top event risk in the week ahead is Wednesday’s FOMC rate decision where the markets await rate forecasts and possibly a timeline for the taper
  • While both the Dollar and risk trends are tuned into US monetary policy, restricted market conditions present an overwhelming restraint to overcome

A Record High to Confuse the Markets on Market Conditions

Where you get your news from matters. For example, there are a number of headlines that tout the record high close from the S&P 500 to close this past week. However, that doesn’t give much insight considering the context shows there was no follow through to speak of for that benchmark nor consistency in risk appetite in other sensitive assets. It is difficult to muster a serious run on risk appetite at this juncture. The backdrop speaks to severe restraint in market conditions with volume and volatility sliding in tandem while anticipation for the Fed rate decision on Wednesday will actively dampen intent by the speculative masses to build up a risk position so close to a global market-moving event. For those looking for guidance from ‘risk-leaning’ assets’ performance, it is important to look broadly rather than top performers like the US indices. What’s more, participant is critical. A measure of volume, open interest, volatility and correlation defines what I consider ‘market conditions’ which often overrides fundamental and technical analysis.

Chart of the S&P 500 ETF Overlaid with 20 and 100-DMA with Volume (Daily)

Dollar and S&P 500 Breaks Must Abide the FOMC Decision This Week

Chart Created on Tradingview Platform

Whether you are a trader looking for more productive price action or prescribe serious weight to the event risk on tap, the top event risk this week can encourage expectations for a true reversal in sedate market conditions. It is certainly possible, but it is important to evaluate markets for what they have to offer rather than what we would prefer. Taking stock of underlying market conditions, there is certainly a curb on activity that is working against an introspective market response to critical developments. ‘Participation’ across the entire market is difficult to measure, but the Spyder S&P 500 ETF as the most heavily traded benchmark can act as a good stand-in. That said, volume has dropped as the VIX volatility index has dropped to levels not seen since before the pandemic. Such measures match seasonal expectations, but it is also highlights extremes such as the ‘tail risk’ (SKEW) and complacency in options (put-call ratio at extremes) alongside the record high use of leverage at the broker level (NYSE). It is not a ‘cheap’ quiet for the financial markets.

Chart of the VIX Index Overlaid with S&P 500 ETF Volume and 10-Week Mov Avg (Weekly)

Dollar and S&P 500 Breaks Must Abide the FOMC Decision This Week

Chart Created on Tradingview Platform

Top Event Risk This Week: The FOMC Rate Decision

While I’m sure there is someone out there that would dispute this: I believe the top event risk over the coming week is the FOMC rate decision. The Wednesday afternoon release is certainly an even that will rouse the Dollar and US capital markets, but it is surely a global catalyst. Consider the role the US central bank has taken as a leader amongst its peers since the Great Financial Crisis (GFC) back in 2008. It initiated large scale asset purchase programs (LSAPs) and has steered ever since. Back in 2013, the Fed started the slow shift from extreme accommodation in an effort to sooth the market’s fears of the inevitable. This time around the Bank of Canada (BOC) has already tapered, but it doesn’t have a global footprint. And so, the Fed decision stands as the symbolic guide for the developed world with action or delay echoing across the financial spectrum.

Chart of Major Central Banks’ Balance Sheets in Billions of US Dollars (Monthly)

Dollar and S&P 500 Breaks Must Abide the FOMC Decision This Week

Chart Created by John Kicklighter with Data from Central Banks

Given its importance, the FOMC rate decision deserves a full breakdown for its critical components and probable scenarios. Below, I lay out the considerations I am following for the event. First and foremost, I don’t expect an actual taper – much less a rate hike from the world’s largest central bank. That would send the market (and economy) into a tailspin which the central bank actively looks to avoid. Instead, the point of controversy is far narrower. We are looking for any explicit indication that the Fed is actively discussing the time frame of its taper. The Fed’s most active and sensitive tool at this state is forward guidance / messaging. A warning of the first reduction in asset purchases will proceed the actual cut which in turn is before a full halt of stimulus infusions which is a necessary step before a rate hike is considered (unless things are really going afoul). As such, I am looking for reference for taper discussions at Wednesday’s meeting and believe the rest of the market will as well – or at least they will respond to such news.

Chart of FOMC Scenarios

Dollar and S&P 500 Breaks Must Abide the FOMC Decision This Week

Table Made by John Kicklighter

The Dollar’s Connection to the FOMC

While I consider the Fed decision an event with global market moving potential, its impact will be particularly concentrated for the Greenback. The Dollar managed a bullish break to close this past week which I believe to be a ‘relief’ move. The benchmark currency was carving out an exceptionally narrow range this past week such that a hold all the way until the Wednesday event risk would have likely resulted in an extreme resolution – aka a severe breakout, as much a productive of the congestion as the event catalyst. The relief through Friday was a break in the ‘path of least resistance’ vein. This will open up the possibility of a bullish or bearish response to the fundamentals next week. Remember that if you were consider asymmetrical scenarios on key events.

Chart of DXY Dollar Index with 20, 50 and 100-DMAs (Daily)

Dollar and S&P 500 Breaks Must Abide the FOMC Decision This Week

Chart Created on Tradingview Platform

If you are looking at the Dollar-based majors for potential in the week ahead, EURUSD and USDCAD offered technical breaks to close this past week. That could theoretically cool the overall potential for market impact ahead, but I believe the event to be significant enough that it could override liquidity curbs with the right outcome. For USDCAD, the break above 1.2150 doesn’t widen the smallest 20 trading day (one-month) range in years. This is an important pair to watch consider the BOC’s taper two months ago, but the Fed’s weight will certainly matter here.

Chart of USDCAD with 100-DMA with 20-Day Historical Range and COT (Daily)

Dollar and S&P 500 Breaks Must Abide the FOMC Decision This Week

Chart Created on Tradingview Platform

While I am interested in other crosses – like EURUSD, NZDUSD, USDTRY and others – GBPUSD is the other top pair to watch through the coming week. Technically speaking, its 20-day historical range is unprecedented in how constrained it is. What’s more, its congestion fits the mold of a head-and-shoulders pattern which stands as a reversal staging. With the Fed decision ahead, there is a ready catalyst, but the Sterling brings its own fundamentals. Broadly speaking, the tension with the EU over Northern Ireland has added serious pressure through EURGBP, but scheduled event risk also includes the UK inflation statistics. This is an interesting pair to watch in the week ahead.

Chart GBPUSD with 100-Day Moving Averages and 20-Day Historical Range and COT (Daily)

Dollar and S&P 500 Breaks Must Abide the FOMC Decision This Week

Chart Created on Tradingview Platform

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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