Fed Taper Focus May Help Curb S&P 500 Collapse and Dollar Load


S&P 500, Evergrande, Risk Trends, FOMC and Dollar Discussion points

  • The week started with a clear aversion to risk, with the S&P 500 forecasting a major trend reversal
  • Risk aversion is more than just a slide of a region or asset class, and fear appears to be on the rise with plenty of fundamental fuel to keep the fire burning.
  • The power of anticipation can help quell a collapse as markets await the FOMC’s decision, but beware if fear persists despite the risk of the event.

It was a technical gesture that didn’t just cut hair in four

Last week, the possibility of risk aversion gaining ground in the financial system was debated. Of course, there were a lot of unresolved fundamental risks strewn across the markets and the S&P 500 technically closed below its 50-day moving average, but the potential for market fears is not in itself deleveraging as the graphics were more nuanced than decisive. At the start of the new week, there appears to be much less debate with global stocks leading to a broader and more intense drop in sentiment throughout the financial system. My favorite single risk measure – though imperfect – offered a separate breakdown on Monday. The benchmark clearly erased its channel floor on significant volume.

SPY S&P 500 ETF chart with volume, 50 and 100 day SMA and 1 day rate of change (daily)

Graphic created on TradingView platform

With the markets under such remarkable pressure, it is natural to look for a reason. As expected, China’s Evergrande has raised fears that an unresolved contagion risk could shatter the inherently unreliable complacency ensuring stability. This is not the only abstract risk with potentially extensive influence in global markets. There is also the threat of the US debt ceiling being breached earlier this month and the momentum of the latest wave of coronavirus cases that pose their own threats. Still, the situation with China’s second-largest real estate developer had come to a head with the possibility of loan interest defaults this week. So far, it appears that the problem has not been “solved” by the Chinese authorities, but it is highly unlikely that the government will let this particular company’s problems turn into an uncontrolled systemic threat to the economy. Chinese. However, when fear sets in, the particular driver matters much less to market participants than the deterioration of confidence itself.

Graph Evergrande with volume and 20, 50-day SMA (Daily)

Fed Taper Focus May Help Curb S&P 500 Collapse, Dollar Charge

Graphic created on TradingView platform

Separate the catalysts of sentiment

There is a huge difference between a market or an asset class under pressure and a risk aversion in its own right. The former develop around specific catalysts, but they tend to be less definitive and burn faster. This is because the re-pricing effort can occur more quickly. When it comes to general risk trends involving the entire financial system, the time and wealth required to strike a balance can be much more important. To assess such a systemic view of the market, my preferred assessment is the correlation between otherwise loosely linked assets. This metric offered a strong and clear signal to start this new week. Correlations between US and global equities, emerging market assets, junk bonds, carry trades and risky commodities strengthened noticeably with a pullback on Monday.

Performance chart of the S&P 500 by calendar month

Fed Taper Focus May Help Curb S&P 500 Collapse, Dollar Charge

Chart created by John Kicklighter with data from Bloomberg

I would definitely say risk aversion was there to start this week, but that doesn’t mean there’s a lasting trend to fall back on. The correlation between different assets is a big escalation towards sentiment, but a lasting trend is the conviction threshold. I don’t think we’ve reached that climax – although we can certainly develop a “taste” for the extreme risks that manifest in an extreme exposure setting. If feeling got the better of it, the tide would be deep. Yet until we see such a dynamic take hold, history suggests it’s best to remain skeptical.

Market risk trend intensity graph

Fed Taper Focus May Help Curb S&P 500 Collapse, Dollar Charge

Graphic created by John Kicklighter

The weight of the US dollar

As we try to sort the market allegiances in fundamental terms, the dollar will be a preferred litmus test for my personal take on intention. I will note that during Monday’s session, despite the strong risk aversion that would develop, the greenback did not retain serious traction as a safe haven. In this case, other safe havens favored during previous crises and which bet on the attractiveness of their liquidity posted sustained performance. This is a serious shortcoming from a risk asset perspective, but it was also a cap for traders looking for a clear setup in a market plagued by ranges. The DXY Dollar Index was modestly higher until Monday’s session, but all of those gains were sold before the close to record a slight loss on the day and maintain a “right shoulder” on a head-to-shoulder pattern.

DXY Dollar Index Chart with 100 SMA (Daily)

Fed Taper Focus May Help Curb S&P 500 Collapse, Dollar Charge

Graphic created on TradingView platform

For the dollar, anticipating a major event risk later in the week may actually help cap risk aversion – when it is more often the disruptive agent for efforts. of “risk on”. Fueling a deleveraging campaign is just as speculative an undertaking as the other way around, but we’re here baffled by the recognition that the Federal Reserve’s rate decision and forecast is due Wednesday afternoon, Washington time. This could prove to be a boon for those with a lingering bullish outlook (or more likely a bearish buying mentality) as commitment to the bearish trend after a long wait for the post-pandemic rise is difficult to muster. in these markets. We envision the next 24 hours with no critical in-game event risk, which will only intensify the impact of Wednesday’s major crop of events.

Risk of economic event from Tuesday to Thursday morning

Fed Taper Focus May Help Curb S&P 500 Collapse, Dollar Charge

Calendar created by John Kicklighter

Looking ahead, the FOMC’s rate decision has a few important aspects. First of all, I don’t expect the central bank to be close to considering a change in its benchmark rate. Instead, the questions will involve intensions with the group’s stimulus program. The issue of typing is the main concern of the market. Will the US political authority be frightened by a late easing of its massive monthly asset purchases by an unstable financial system? We are in a scenario where the central bank can be “wrong” no matter what decision it takes. If the Fed were to decline, it could be seen as compounding the market’s woes without the support of its biggest promoter. Then again, an extension of the $ 180 billion in purchases per month could be interpreted as an admission that the financial system is so fragile that it requires such attention.

FOMC Scenario Table

Fed Taper Focus May Help Curb S&P 500 Collapse, Dollar Charge

Table created by John Kicklighter

The alternatives

Apart from the FOMC decision, the Wednesday to Thursday case will strike well above its weight. I think the holistic picture of monetary policy supporting a prospect of exorbitant risk is a fragile arrangement that the Bank of Japan, Bank of England and others (SNB, BCB, etc.) will exploit. That said, the mere prospect of “growth” is a more basic metric that traders should be mindful of throughout this active week. Markit’s monthly PMIs may prove to be a much bigger influence in the market, given the general disposition, but the drop in August numbers sets the tone even more.

PMI growth measures of major economies (monthly)

Fed Taper Focus May Help Curb S&P 500 Collapse, Dollar Charge

Chart created by John Kicklighter with data from Bloomberg, Markit

For market movements, sharp “risk” assets like the S&P 500 are the most exposed to volatility, but I’m more interested in measures that can exploit more than the risk / risk balance. The USDJPY is one of those multi-faceted pairs. The Fed is considering its possible turn to a hawkish group while the Bank of Japan has three decades of ultimate dove under its belt. Additionally, all yen pairs are considered risk sensitive given their carry weight, making them a multidimensional pair. The more complex pair heading into the middle of the week is the USDBRL. Not only is there a clear ‘risk’ for the pair, but economists expect the Brazilian central bank to raise its benchmark rate by 100 basis points – a serious escalation from the simple taper schedule of the dollar. Fed.

USDJPY Chart with 200 Day SMA (Daily)

Fed Taper Focus May Help Curb S&P 500 Collapse, Dollar Charge

Graphic created on TradingView platform

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