S&P 500 or EURUSD: which will break first?

S&P 500, USDJPY, EURUSD, Growth Forecasts and Rate Rising Talking Points

  • The business perspective: S&P 500 bearish below 4,075; EURUSD bullish above 1.0800; USDJPY bearish below 132.00
  • The S&P 500 extended a tightly constrained 100-point range for an eighth session while the EURUSD held within a 150-pip range for 11 days
  • While the ECB’s rate decision is a very explicit catalyst ahead, don’t underestimate the impact of growth and general monetary policy downgrades for the S&P 500

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On risk trends

“Markets can stay irrational longer than you can stay solvent.” This adaptation of the saying of John Maynard Keynes strikes me as perfectly applicable to the conditions we face with the S&P 500 – and by large “risky” assets in general. I tracked the remarkable constraints of the US equity benchmark every day; and with Wednesday’s close, the tally has reached eight consecutive trading sessions in which the world’s most liquid currency pair has held within an exceptionally tight 100-point range. The last time we saw the market so quiet was until January 4e which were commercial holiday terms. Our circumstances are very different today than they were then. Prior to this benchmark, we had experienced various periods of market fatigue throughout 2021, but conditions are now very different than they were in this supply of complacency-driven risk exposure. Between extreme inflation, aggressive rate forecasts and a gradual shift in rate forecasts; consistency in the most speculative risk measures seems more than suspect.

Chart of the S&P 500 with 50-day SMA, 7-day ATR and 7-day historical range (Daily)

Chart created on Tradingview platform

As far as “risk assets” go, the S&P 500 – and US indices more broadly – ​​are what I consider to be the most resilient speculative group in general. Over the long term (ie over the past 10 years), US equities have significantly outperformed in the post-Great Financial Crisis era. However, if we shorten that timeframe significantly, it wouldn’t be an exaggeration to say that the yen crosses outpace all major “risk” categories. All major yen crosses have jumped over the past month – even CHFJPY – but high yield pairs have benefited from some of the biggest moves. While GBPJPY and NZDJPY are worth evaluating, USDJPY is in a class of its own. The 1.2% rally in this second most liquid pair is the biggest one-day rally in six weeks. More than that, the charge extends an 8-day rally that is only comparable to the post-pandemic or US election period. In other words, it’s extreme. Speaking of extremes, we are within 100 pips of the swing high set in January 2002, which will register on the radars of even technical agnostics. It’s a pair to watch around its highs, but its real capacity for movement comes in case appetite might crash again.

USDJPY chart with 50 and 200 day SMA, 7 day rate of change (daily)

S&P 500 or EURUSD: which will break first?

Chart created on Tradingview platform

Monetary policy is back on the menu

While the S&P 500 is unique in its reflection of the market squeeze for a multitude of reasons, it is by no means alone when it comes to the potential for a significant breakout. Another financial system benchmark, the EURUSD pushes the statistical extremes and has a more muted fundamental spark that has the ability to pull the market out of its oppressive range. Looking at the chart, the benchmark Forex cross has been swinging between 1.0800 and 1.0635 over the past 11 trading days. It is as narrow a corridor as we have seen from this landmark as we have seen from the very beginning of the year. Unlike the US index, there is a very specific event risk that we can flag that is likely to generate volatility for the euro; the ECB’s rate decision. While no changes are expected at this particular meeting, speculation of a rise in July and September is virtually entrenched. If this resilient dove gives way to inflationary pressures, it could reverse monetary policy from complacency-based risk appetite. If they hold out, it could quickly undermine the euro’s rally last month.

EURUSD chart with 20 and 100 day SMA, 11 day historical range (daily)

S&P 500 or EURUSD: which will break first?

Chart created on Tradingview platform

Speaking of monetary policy in a more general perspective, it is important to put the ECB in context. There are really only three major central banks that are holding back their fight against inflation to “officially” support growth, although there is good reason to suspect that currency manipulation is on the cards. Dismissing the SNB which has kept a negative rate simply to do “just a bit more than the ECB”, the Bank of Japan (BOJ) seems determined to anchor its 10-year JGB yield in a bid to stimulate growth – despite the pressures inflationists. This has really pushed the yen crosses towards the highs we are currently testing. That said, the ECB has seen the assumptions settle for the euro and regional benchmarks. Until the end of the year, the swaps incorporate a reference rate of 0.68, which represents an aggressive reversal from the main rate of -0.50% currently supported. If this group decides to withdraw from its implacable lodging, this has important implications for the value of the euro; but beware, its influence is broader on global “risk trends”.

Chart of benchmark lending rates of major central banks (monthly)

S&P 500 or EURUSD: which will break first?

Chart created by John Kicklighter

When will we recognize the recession in the room?

I had misread the calendar this week. I had mixed the releases of the World Bank and OECD growth forecasts and therefore was unprepared for the latter’s update in the last session. Ultimately, the data matched the issues we saw in other statistical venues. For global growth, the OECD has lowered its “global” forecast from 4.5% in 2022 to 3.0%. That’s a steep drop, but not particularly surprising. We’ve seen the potential for economic expansion gradually slide from the IMF’s spring forecast to the Markit PMIs to the data we’ve seen this week. Nonetheless, the pressure remains…and the deviation from where the major risk indices are floating is worth watching. The next high-level US economic forecast will be released next week along with the FOMC’s Summary of Economic Projections (SEP) update accompanying its rate decision.

Table of OECD economic forecasts

S&P 500 or EURUSD: which will break first?

OECD forecasts and table

The threat of an economic recession is serious…but the market has a way of downplaying the threat until it is undeniable. When it comes to a reversal in growth, it is a fundamental “end” to so many of the “means” that we debate from week to week. I conducted a survey to see what the average trader (on Twitter) thought was the likelihood of a recession for a “major” economy in the coming year. Probability categories of 50-75 and 75-100% were evenly distributed. Ultimately, risk trends are the end game when it comes to global markets and trend development, but economic activity and potential is what I see as a dominant driver. We would do well to watch for important data and critical forecasts like the FOMC SEP going forward.

Poll asking the probability of a recession for a “major” economy

S&P 500 or EURUSD: which will break first?

Table from twitter.com, @JohnKicklighter

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