It feels that we will look back at the last few months and use this period as a case study on how markets interact with central banks. In particular, the role financial markets have played in anticipating and then shaping Fed policy.
My view, for what its worth, is this originated as a communication mistake from Jerome Powell on 4 October, with the Fed Chair saying the fed funds rate was ‘a long way from neutral’. As we can see from the Bloomberg chart, this marked the high in the S&P 500 (green), the start of a wider high yield/IG credit spread (purple – inverted), and subsequently moves in the rates markets (white lines). Here, we the rates market going as far as pricing a full rate cut (from the FOMC) between September 2019 and 2020 on 3 January. 
There has been some re-pricing, but we are not out of the woods with 15.5bp of cuts still priced through this period – so, the Fed still needs to tread carefully.

This faux pas from Powell was then walked back on 28 November, with talk that the fed funds rate was now just ‘below the low estimate of the neutral range’. The markets continued to sell risk, however, assisted by a falling oil price and a synchronised global growth slowdown, with expectations that the Fed would strongly acknowledge this in the 20 December FOMC meeting. That failed to play out, with the bank refusing to alter its guidance and the markets then sensed a policy mistake. 
This is the point where we knew the markets were in control, and they were telling the Fed a very clear message; that being, one of concern, and that a policy mistake had likely been made. Jerome Powell changed the game in his speech at the American Economic Association (on 5 January), acknowledging the market’s message, and that should these concerns actually play out, then the Fed would have no problems looking at the pace of balance sheet reduction, as well as pausing its hiking cycle – the Powell ‘put’ was born. 
However, since then, we have had a mass migration to the extended pause camp, and that includes even the most hawkish contingent on the Fed, such as Cleveland Fed governor Mester. Powell has rounded up his troops, and we now have a fully unified stance from the Fed. 
The market didn’t like what it originally heard from Powell, and sensed that he was happy to be a high vol Fed chair. But their rebuttal was aggressive, ultimately, pushing the Fed to a point where it had no choice but to respond, and even if the world’s economy proves to not as bad as what was being priced, when financial conditions tighten radically, the Fed will respond.  
What is bizarre is the minutes of the 20 December FOMC meet (released at 6 am this morning) were surprisingly dovish, and one questions, why on earth this message in the minutes, was not announced in Powell’s presser? It’s just another communication mishap from the Fed chair, and gives us a belief that if the market wants something, they know they can boss the world’s most influential central bank – this is important.
Key charts on the radar
S&P 500 – Clearly at a make or break juncture, with price action reflecting this and we can see this indecision highlighted by the ‘doji’ candle on the daily. After a 10% rally since 4 December, we are testing strong horizontal resistance, with price moving in a wedge pattern. With the Fed now having moved towards the market, is the relief rally over as we now hot what we asked for? Is this the place to start revisiting shorts again? As always, we trade price and how price reacts here should be fully respected. Personally, I would be cautious from taking new longs here, that is, until the bulls have shown they have the impetus to push the index through 2600. 

US Q4 corporate earnings – Is it time to focus more closely on the micro? With US close to 10% of the S&P 500 market cap reporting Q4 numbers next week, perhaps it is. The analysts’ consensus is forecasting EPS, and revenue growth sits at 13.2% and 3.7% respectively. This chart from Bloomberg, looks at the changes to consensus earnings forecasts, not just for the US markets, but globally. As we can see, the re-rating has been the biggest negative revision since 2009.
(Source: Bloomberg)
Asia Pac equities – If I look at the Bloomberg ‘fear and greed’ index on the MSCI Asia Pac Index, which looks at the ratio of buying to selling strength, and who is in control of a move and can indicate if there is too much euphoria or pessimism. As we can see, the recent move seems stretched and seems to be a reason for a weaker session today in Asia. Another reason for me to feel cautious from putting new money to work on the long risk side.

WTI crude – Such an essential market for semantics more broadly, as higher oil is causing inflation expectations to rise more aggressively than nominal bond yields. This has the effect of lowering ‘real’ bond yields, which is positive for equities but is also a negative for the USD. Key resistance in US crude is seen between $54.50 to $55.50, so I would expect traders to lean into this supply zone.

USDCNH – Put this on the radar – While the common denominator here is the USD, USDCNH seems to be the driving force for both EURUSD and AUDUSD. Here, we see:
•    Upper pane – AUDUSD (inverted – red) vs USDCNH•    Lower pane – EURUSD – (inverted – yellow) vs USDCNH

Daily chart – While we don’t expect the price to collapse, this FX cross tends to be a low beta pair, but, as we can see, the USDCNH is breaking horizontal support and affecting other pairs in G10 FX, as per above. One to watch, but if the selling does accelerate, then it should weaken the USD more broadly. 

Published by Chris Weston, Head of Research, Pepperstone