Talking Points on the S&P 500, Liquidity, GDP, Chinese Dollar and EURCAD

• The business perspective: S&P 500 bearish below 4,000; USDCAD bullish above 1.2500
• A 1.8% rally in the S&P 500 pushed the index to a one-month high, but we barely pushed its range…all while volatility preparedness is dangerously low
• Major themes of inflation, rate forecasts and growth forecasts, as well as key event risk from NFPs and the ISM services report, make the dollar a lightning rod

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S&P 500 Hits One-Month High: Inspirational or Liquidation?

We head into the final session of the trading week with a positive trend in risk assets, a remarkably bullish picture of potential volatility, and anticipation for major risk events. These aren’t exactly uncoordinateable conditions, but they do create a platform where the market is prone to a “surprise” reversal in sentiment. As it stands, the S&P 500 made a strong impression with its major US counterparts as it rose 1.8% to close at its highest level since May 4.e. On paper, this might seem like impressive progress, but it’s hardly a remarkable move in terms of pace considering the ATR over the past month. Moreover, we have only modestly exceeded this level. Since the near failure of a “bear market” two weeks ago, the index is now 9.6% above its lows. With fundamental headwinds so evident, I still view this as a bear market bounce; but the upside may continue as long as it is not hammered by sentiment or a fundamental update.

Chart of the S&P 500 with 20-day SMA, daily wicks and 20-day ATR (Daily)

Chart created on Tradingview platform

Generally speaking, the market can turn with little notice and on a less than revolutionary update. However, I believe the conditions are particularly conducive to seeing a dramatic rather than a measured turn. There has been a slow moderation in volatility for benchmarks like the S&P 500 as the rebound progresses. That said, “realized” measures of activity (like the ATR) remain exceptionally high. As for the “implicit” gauges, the VIX volatility index is still above its 200-day moving average; but it’s the extreme impact on the VVIX “volatility of volatility” index that really stands out. After plunging below 90 in Thursday’s trading session on a six-day decline, there is growing evidence that markets are not well positioned for any sudden changes in direction and momentum. Poor preparation tends to result in a messier response; and it is a general rule that ‘fear’ tends to hit the markets much harder than ‘greed’.

VVIX ‘Volatility of Volatility’ Index Chart and Consecutive Daily Movements (Daily)

Chart created on Tradingview platform

Most Fundamental Roads Lead to the Dollar

As the last trading day of the week approaches, it is important to keep track of general “risk” assets; but there is one particular market that will find itself positioned at the crossroads of the most fundamental waves – whether they swell or not. The greenback had a particularly active session on Thursday with the DXY Dollar Index posting a -0.8% correction that quickly killed off the recovery effort from earlier in the week. The rebound in risk trends is undermining the appeal of the benchmark currency’s safe haven, but that doesn’t seem to have had a particularly significant influence of late. Instead, a drag on the relative US growth advantage and a shift away from Fed rate expectations appear to be a more active driver. As I watch the USD for its own performance, my interest in crossovers is particularly acute on the EURUSD bounce between 1.0800 and 1.0650 as well as USDCNH as it carves out a big reversal in the middle of the political headwinds.

Chart of DXY Dollar Index with 50 and 100 day SMA, 1 day ROC and 20 day ATR (daily)

Chart created on Tradingview Platform

In terms of event risk in this latest session, there is monthly seasonal interest in the release of the monthly US labor report. The non-farm payroll is perhaps the most recognizable economic version for traders and non-traders alike and this ubiquity tends to lead to greater market response as the data tends as speculative ranking attempts to value data in capital barometers. The consensus among economists stands for a net increase in payrolls of 325,000 for the month of May, which would be a significant slippage from the performance of the previous reading. That said, ADP’s private payrolls figure released on Wednesday suffered a significant shortfall from the consensus forecast. The signaling power of the first reading isn’t particularly robust when it comes to the official government reading, but it still sets the tone. The real question is whether employment statements – payroll, unemployment rate, earnings, etc. – have a greater influence on interest rate expectations or confidence in growth forecasts.

Graph of NFP evolution, ADP private payroll evolution and differential (monthly)

Calendar created by John Kicklighter with data from BLS and ADP

What matters more on Friday and beyond: monetary policy or GDP?

When it comes to interest rate speculation, there seems to be a moderation in the daily swings that follow the chart. The relentless dollar charge from February to mid-May – as expectations for steady rate hikes rose to include a series of 50 basis point moves and culminated in the extreme anticipation of one or more 75 basis point increases base – seems to have reached a plateau. That said, Fed rate expectations are not simply succumbing to a steady path of decline, as seen in Fed Funds futures this past session. While the 50bp rate hikes in the June and July meetings are still firmly entrenched (with some modest speculation of a 75bp move over this period), we have seen the prospects for a further move in 50 bps as of September 21.stjumped to 70% from 37% just a week ago. Clearly, this is an active theme; but I just don’t think the employment side of the dual mandate has much potential to significantly influence the Fed’s course before an extreme change.

Chart of likely FOMC rate level in September based on Fed Funds futures

Chart created by John Kicklighter

Contrary to the monetary policy implications of the next employment report, the impact on growth forecasts is more significant. We have seen the outlook for economic health drop significantly in recent months through IMF forecasts, PMI numbers and warnings from the White House (in the case of the US). We expect an update of the OECD forecasts next week; but for now, the jobs report can offer a milestone of the “real” numbers. That said, the most influential economic read on my ledger relative to NFPs is the ISM services sector report for May. This report focuses on a segment of the economy that accounts for more than three-quarters of production and jobs. A slight rise could offer relief as long as it doesn’t come with as many caveats as its factory counterpart released earlier this week. If it misfires, beware of the implications for the S&P 500 and the dollar.

Chart of the S&P 500 overlaid on US services and manufacturing activity from the ISM (monthly)

Chart Created by John Kicklighter with data from ISM