Indices Technical Forecast: Neutral
It was a huge week for stocks with a massive move showing up after the Fed’s rate hike on Wednesday. The FOMC hiked rates by 75 basis points and the S&P 500 jumped up to a fresh six-week-high. That move continued on Thursday and into Friday trade, helped along by earnings reports from Amazon on Wednesday afternoon and Apple on Thursday.
The S&P 500 gained over 5% from the Tuesday low up to the Friday high – and the Nasdaq 100 put in a whopping 7.48% advance. This move has many saying that the bottom is already in and there were even some claims that ‘the recession is over.’ I’d be careful with making big picture assumptions from a short window of price action, but nonetheless the intensity of these moves needs to be noted.
In last week’s installment, I highlighted the Treasury market along with the message that it may be sending. That theme continued this week as US Treasuries yields fell further and the 10-year is now at it’s lowest rate in more than three months, pushing below the 2.7% marker. Since the last time the 10-year was this low, the Fed has hiked rates by 200 basis points and yet, longer-term yields have continued to drive-down.
US Treasury 10-Year Yields, with FOMC Rate Hikes Since May Added
Falling Yields as a Bullish Factor?
Even with the Fed hiking, longer-term treasury rates are falling and this is happening in an uneven manner. The long-end of the curve is seeing yields fall even faster than the short-end of the curve, leading to deeper inversion, which is generally considered a bearish factor. That said, it’s also not necessarily a great timing indicator as the distortion produced by an inverted yield curve simply signals that something is amiss, not that it’s nearing the point of breakdown.
At this point, the 2/10 yield spread, measuring the difference between yields on the 2 and 10 year Treasury, is at its most inverted since September 2000. The dynamics that drive this theme are what matters: Even as the Fed is lifting rates and helping to boost the short-end of the curve, yields on the longer-end of the curve are falling – why would that be?
Well rates are determined by markets, not the Fed, and even as the Fed is lifting the discount rate (what the Fed charges banks to borrow funds), investors and fund managers are buying longer-dated treasuries and that increased demand is what helps to push treasury yields lower. But more to the point, why would fund managers be buying longer-dated treasuries when rates are going up? Since yields and prices are inverse, wouldn’t the higher rates from the Fed spell lower prices for bonds, particularly longer-term bonds that would be more impacted by that rate differential with the greater term?
Normally, yes; but yield curve inversion is abnormal and this is what makes it interesting – it highlights distortion.
If market participants are buying longer-term debt even as short-term rates are rising, this is usually an expression of the expectation that rates will eventually fall again. And when rates do fall – those bond prices can perk up, leading to a principal gain on the bond. So, these investors may not be looking to buy 10 years of duration so that they can clip coupon payments but, instead, may be making a trade based on the expectation that the Fed will eventually start cutting rates again.
This is also a reason why yield curve inversion may not be a great timing indicator while it certainly does send quite the contextual message to market participants.
US 2/10 Yield Spread Monthly – Most Inverted since 2000
Chart prepared by James Stanley;
The S&P 500 added more than 5% from the Tuesday low into the high at the end of the week. The index has also set a fresh seven-week-high, while trading to and jumping through a spot of resistance around the 4100 handle. I noted this as a level of interest in last week’s forecast, highlighting how a support hold above 3922 could lead to an extension of the prior week’s bullish move.
Support on Tuesday showed up at 3915, which is the 23.6% Fibonacci retracement of the 2022 sell-off, and also the swing-high from two weeks prior. The daily candle’s body closed at 3923 while the wick from that candle touched 3915 briefly, helping to confirm that support level. That level then acted as a launching pad for the move.
The 38.2% retracement from that same study plotted at 4085 and was confluent with the 4100 area; and that held the highs on Thursday. Normally, after a strong move with a level of that nature coming into play after a big move, there would be some element of pullback. This would be the higher-highs and higher-lows that price action will generally show during a building trend. After all, buyers would usually want to take profits after such a run, right? The fact that this didn’t happen indicates that something else may be afoot.
This illustrates a move that feels rather extreme to me. I’m of the opinion that at least some of this is short-squeeze related. As markets were pulling lower in early-June sentiment had grown quite bearish and with rates now falling, and markets speculating that inflation may have topped, the ‘buy the dip’ mentality that I noted in this quarter’s Top Trade has taken-over.
I’m still viewing this bullish run as a correction in a bigger-picture bearish theme. But given how strong the move has come-in, prices may not have topped out yet and there may be more run in store. The next area of resistance on the chart is a major one, spanning from Fibonacci levels at 4186 up to 4223, the latter of which is the 50% marker of the 2022 sell-off. If bulls are able to sustain a break above that level, the bearish trend would be in question. But, it looks as though this theme may be nearing its toughest test yet in the red zone on the below chart.
S&P 500 Daily Price Chart
The Nasdaq added more than 7% from the Tuesday low into the Friday high and spanning back to the June low, this brings the running tally to 16.73%. While this is a massive move, it’s also a bit less than the 17.97% that posted in the index in the final two weeks of March before sellers were able to re-take control of the situation. The prior iteration in March led to another bearish run, with sellers taking over again in April and leading to a -27.51% run from the late-March high to the June low.
After that June low, a falling wedge formation built and those are often tracked with the aim of bullish breakouts. The breakout showed in early-July and prices checked back for support at prior resistance a week later.
At this point, the Nasdaq is testing a zone of resistance between tow Fibonacci levels of note. At 13,050 is the 23.6% retracement of the 2009-2021 major move. And at 12,894 we have the 38.2% Fibonacci retracement of the April 2020-November 2021 move. This zone helped to catch support in the Nasdaq in February, March and April before finally giving way in May. And now it’s back as resistance.
If sellers can hold price below 13,050 in the early-portion of next week, reversal themes can become attractive.
Nasdaq 100 Daily Price Chart
The Dow traded through a confluent resistance zone this week that sat around 32,400. There were two Fibonacci levels in tight proximity and this is the same zone that had held support in March, just before the Fed-fueled rally pushed into quarter-end.
The next spot of notable resistance in the Dow sits around 33,236, which is the 50% mark of the 2022 sell-off. This is also the same area that held the highs in late-May and early-June before prices put in a strong bearish push down to the current yearly low. There was a grind of price action resistance that ran for a week-and-a-half before sellers were able to take-control, and this highlights that zone as a key spot on the chart should bulls continue to push.
Beyond that, there’s another confluent area from 34,084-34,133, with a couple of Fibonacci levels to go along with a bearish trendline projection.
Dow Daily Price Chart
— Written by James Stanley, Senior Strategist, DailyFX.com & Head of DailyFX Education
Contact and follow James on Twitter: @JStanleyFX