“…following Thursday morning’s consumer price index (CPI) report that came in below expectations, market participants quickly backed off the probability of a 5.00% or higher fed funds rate by March 2023. The eve before the CPI release, fed funds futures traders assigned a 63% probability that the fed funds rate would be at 5.00% or higher in March 2023. Hours after the CPI report, on Thursday afternoon, that probability had fallen to 30%”
- Monday Morning Outlook, Nov. 14, 2022
“Fed Vice Chair Lael Brainard briefly buoyed sentiment after she said, during a Bloomberg event in Washington, that it would be appropriate ‘soon’ for the central bank to slow its pace of interest-rate hikes. However, she also emphasized that the Fed had ‘additional work to do’ to bring inflation down, which kept some investors on the edge.”
- Bloomberg, Nov. 14, 2022
“Pausing is not part of the discussion…”
- Mary Daly, President Reserve Bank of San Francisco, CNBC TV, November 16, 2022
“We have not made enough progresas…We still have a ways to go…”
- Christopher Waller, Fed governor, Nov. 16, 2022
“…the change in the monetary policy stance appears to have only had limited effects on observed inflation, but market pricing suggests disinflation is expected in 2023…the policy rate is not yet in a zone that may be considered sufficiently restrictive…”
- James Bullard, President Reserve Bank of St. Louis, Nov. 17, 2022
Per the excerpt above from my commentary last week, an economic report or a Federal Open Market Committee (FOMC) meeting can quickly (and drastically) change the market’s view on what path interest rates will take in the months ahead. As we saw this week, so too can comments from Fed governors or regional presidents.
After the prior week’s consumer price index (CPI) number came in below expectations, a lower-than-expected producer price index (PPI) was released last week. These reports set a positive tone in the market, but a multitude of Fed members walked back the excitement, with a common thread being that there is a ways to go to get targeted inflation back to its 2.0-percent target zone.
The unified message from several Fed members again changed the perception of where the fed funds rate will be in March 2023. After the CPI data was released the week prior, fed funds futures traders placed a 30% probability of the fed funds rate being at 5.00 percent or higher after the March 2023 FOMC meeting.
Per the table below, by Friday afternoon this probability had risen to 47%. As a result, stocks declined amid hawkish comments that surprised some market participants who were looking for something more dovish on the heels of lower-than-expected October inflation data.
“If the rally continues, the next level of potential chart resistance for the SPX is at the 4,000-millennium level. Not only is this a big round psychological number, but it is also a 38.2-Fibonacci retracement of this year’s high and low. Just 2% above this millennium mark is the SPX’s declining 200-day moving average at 4,080, which marked peaks in April and August.”
- Monday Morning Outlook, Nov. 14, 2022
Tuesday marked the S&P 500 Index’s (SPX – 3,965.34) intraday and closing highs last week, its highest level since mid-September when a bearish “island reversal” pattern set in a motion a sharp decline into mid-October. While the index pushed above the 4,000-millennium mark intraday last week, it never closed above this important level and, as such, still represents a potential area of resistance in the near term.
As it was mentioned last week, there is work to be done as potential longer-term resistance levels come into play even if the SPX moves above the 4,000-millennium mark.
For example, the declining 200-day moving average currently resides at 4,067, which is 13 points below where it was going into last week’s trading. And the trendline connecting lower highs since the SPX’s all-time closing high in January comes into this shortened holiday trading week at the round 4,100-century mark and ends the week in Friday’s half-day session at 4,090.
This trendline and the 200-day moving average acted together in marking the August intraday high at 4,325, implying these areas are worth putting on your radar as potential resistance if the SPX moves through 4,000-resistance in the days or weeks ahead.
“…the SPX drove above 3,900, or its July breakout level, above a trendline connecting lower highs from March through June. When the index declined back below this level in mid-September, sharp selling quickly followed. Moreover, at Thursday’s close, the SPX was above 3,942, which was the site of a break-down level below a trendline connecting higher lows from June through early September. The break below this trendline in mid-September was, in hindsight, an early warning signal that heavy selling was imminent… these levels now become multiple potential layers of support.”
- Monday Morning Outlook, Nov. 14, 2022
While resistance came into play at 4,000 as expected, so too did support, with the SPX low last week in the 3,900 region, which was the site of the July breakout above a trendline connecting lower highs from March through June. This century mark went on to act as short-term support in early September and, when broken to the downside, led to a sharp selloff. It acted as resistance around the time of the last rate hike until last week’s move back above this level.
These support levels were good news for bulls, even as investors’ expectations for the path of future rate hikes were adjusted by FOMC members last week to expect a more hawkish policy in the months ahead relative to expectations entering last week’s trading.
If 3,900 does break early this week, the trendline connecting higher lows since the October bottom could be a level of secondary support. This trendline comes in the week at 3,858 and ends the week, coincidentally, at the key 3,900 level.
On the volatility front, an encouraging sign for bulls is that the CBOE Market Volatility Index (VIX -- 23.12) is below a trendline connecting most higher lows since November 2021, when the Fed warned market participants that a more hawkish policy was imminent. This VIX retested this trendline multiple times last week and closed below it, with the Tuesday peak around the level that corresponds with the level that is 50% above last year’s VIX close.
If the VIX advances in upcoming days, I would consider a move above the 26 area as a caution sign that higher volatility could be ahead. Per the chart below, VIX futures option buyers are bracing for higher volatility, as is evident by the high 10-day call/put volume ratio, which is above 4.0 currently. This group has a decent historical track record, although they were dead wrong in mid-July when buying calls at a brisk pace relative to puts. This is something to keep on your radar.
Todd Salamone is a Senior V.P. of Research at Schaeffer's Investment Research
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