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S&P chart and the week ahead

By David Morrison  |  09/11/2018 15:24
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The S&P 500 rallied through the 200, 50 and 100-day moving averages following Tuesday’s mid-terms. But will the fear of a hawkish Fed lead investors to sell the rips rather than buying the dips?

On Thursday evening the US Federal Reserve kept its fed funds rate unchanged as expected. The Fed kept its key interest rate within a range of 2.0-2.25% although it is widely expected to raise it by 25 basis-points at next month’s meeting. What was odd was that although the accompanying FOMC statement contained no surprises, at least as far as Goldman Sachs’ preview was concerned, the market reaction suggested otherwise. The dollar rallied while the major US stock indices sold off, suggesting that investors were expecting a more dovish tone from the Federal Open Market Committee (FOMC).

Hawkish Fed?

Perhaps investors were expecting less hawkish statement from the Fed following the sharp risk-off move in October along with President Trump’s criticism of Fed Chairman Jerome Powell and the central bank’s monetary tightening. If so, then they’re still not paying attention. Jerome Powell is a very different Chair from his three predecessors, Janet Yellen, Ben Bernanke and Alan Greenspan. He may not prove to be as starkly apolitical as Paul Volker, but there’s little doubt that he takes the Federal Reserve’s independence seriously. On top of that, maybe some people don’t get this, but taking an honest and principled opposition to President Trump as he blusters on Twitter won’t put a dent in one’s reputation.

Chairman Powell

The other thing to consider, and this can be gleaned from Powell’s speeches prior to him becoming Chairman, is that he’s aware of asset bubbles and the Fed’s role in creating them. He also appreciates the danger of speculative bubbles and the misallocation of capital, especially as this relates to the mispricing of the cost of money (interest rates). Therefore, some commentators have pointed out that the Greenspan/Bernanke/Yellen Put (that is, the point where the Fed intervenes to halt a market sell-off) may not exist under Powell. Or if it does, it will only kick in after we see a substantial correction in major equity indices that could take us well below the 20% high-low fall which defines a bear market.

Rate hikes ahead

So, in the absence of a complete market meltdown or other catastrophic event, we should expect the Fed to keep raising rates, while reducing its balance sheet, at a steady pace until the end of next year. The feeling is that Powell and his colleagues feel the US is overdue a recession and they need to prime the pumps, so they have room to cut rates ‘aggressively’ when it comes.  Currently, the market expects two 25 basis point hikes next year, on top of one in December. This is one less than the Fed is forecasting, and two less than Goldman Sachs anticipates. So, something’s got to give, and it probably won’t be the Fed.

Inflation picking up

In yet another sign that inflationary pressures are building in the US, on Friday headline Producer Prices rose 0.6% month-on-month in October, well above the +0.2% expected which would have been unchanged from the previous month. The news gave the dollar another boost while driving down equities, gold and silver.

Next week’s key economic data:

On Tuesday we have UK employment data and ZEW Economic Sentiment surveys for Germany and the Euro zone. Wednesday morning sees the release of Chinese Fixed Asset Investment, Industrial Production and Retail Sales. Later on, we have UK and US CPI, and Euro zone Flash GDP. On Thursday we have Australian Unemployment, UK and US Retail Sales. On Friday we have Bank of England Inflation Report hearings.

S&P 500 chart

It has been a crazy six weeks for the major US stock indices. The steep sell-off we experienced through most of October gave way to a storming rally going into November. This has seen the S&P 500 break back above resistance around 2,700 before going on to smash through the 200, 50 and 100-day Exponential Moving Averages (EMA) following Tuesday’s mid-term elections. Prices dipped back on Thursday and were weaker again early on Friday as the market went from very oversold at the end of October to very overbought this week. The big question now is how the index behaves going into the weekend as this should give us a good indication of sentiment going forward. Once again, the key levels to watch are the three main moving averages, which for me are the 50, 100 and the all-important 200-day which comes in around 2,760. Now, we’d have to see a very sustained and powerful sell-off to get the index down below this level before tonight’s close. Consequently, it goes without saying that a close below 2,760 would be very bearish news indeed. Similarly, a bounce from current levels taking the index back above the 50 and 100-day EMAs at 2,797 and 2,800 respectively would suggest that there may still be some puff in the market as we head into year-end.

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