US Stocks: Something’s gotta give

The biggest event for stocks this week will be this evening’s FOMC statement released at 1800 GMT/ 1400 ET. Before that comes the much- anticipated ADP private sector labour market report, which is expected to show a 150k increase in private sector payrolls this month. The ADP report has taken on extra significance due to the delay to NFP’s until next week, so watch out for some volatility around 1215GMT/ 0815 ET.

Second guess the Fed at your peril

So far the market has been able to rally on the back of a recent spate of uninspiring economic data from the US as the Fed is expected to assuage a bruised economy with continued QE. But assuming what the Fed will do and the reality of what the Fed actually does are two different things. While the market is expecting a dovish statement from the FOMC meeting later today, we believe the bigger risk right now is the Fed is not as dovish as the market wants. Thus, even a subtle shift of rhetoric or the merest hint that the Fed could consider tapering in the “next few” months could trigger a dollar rally and the markets to sell off. See our note yesterday on whether the markets are too dovish here.

What does this mean for the markets?

A funny thing has been going on this week – the dollar has been rallying alongside US stock markets. For most of this month the dollar has moved inversely to stocks, so as the S&P has climbed to fresh record highs, USDJPY has mostly stayed subdued. However, this relationship has disintegrated over the last couple of sessions with USDJPY jumping above 98.00 and the S&P 500 making another record high on Tuesday, opening the way to 1,800.

FX and stock markets seem to be anticipating opposing outcomes from the FOMC statement: with FX markets not wanting to be short dollars in case the statement is less dovish than expected and the stock market pushing in to new terrain on the back of expectations of continued Fed liquidity.

Can they both be right? To answer this it is worth looking at the performance of USDJPY and the S&P 500 this year.

Overall, the S&P 500 and USDJPY have moved together since Nov 2012 until earlier this month, when the S&P 500 started to accelerate and USDJPY remained range-bound.
The S&P 500 has tended to lag USDJPY over the past year– for example, back in mid- May, USDJPY peaked and then fell pretty much in a straight line through to mid-June when it bottomed out. The S&P 500 peaked around the same time as USDJPY, but it moved in a range while USDJPY tanked, before falling from mid to late June.
Likewise, when USDJPY jumped above 100.00 in early September, the S&P 500 did not reach its peak until 10 days later.

We have seen periods when USDJPY and the S&P 500 have moved in opposite directions over the last 12 months, but overall these divergences have been fairly short-lived and they have resumed moving in similar directions.

Don’t forget…

Of note, after the FOMC meeting in September when the Fed decided not to taper asset prices, the S&P 500 fell more than 4% in the proceeding 2 weeks, USDJPY also fell during this period.


Thus, as we lead up to the October statement the US equity market seems fully priced for a dovish Fed that remains on hold and sounds concerned about the economic outlook. The risk is that the market starts to focus on the fact that tapering is inevitable and even if the Fed maintains QE at its current level for a number of months there is unlikely to be any fresh stimulus going forward. Thus, if reality hits then the S&P rally could be at risk in the next 24 hours and this FOMC meeting could trigger some profit taking, particularly if we get to the psychologically important 1,800 level.

Some levels to watch in S&P 500:

On the downside:

1,768 – Initial support and the daily pivot.
1,725 – The 38.2% retracement of the most recent rally from 8th- 29th Oct.
1,715 – The 50% retracement of the same move.

On the upside:

First pivot resistance at 1,775
Second pivot resistance 1,7778
1,800 – Key psychological level.