Market Record Highs Belie Volatility Risk of Fed and Central Bank Decisions Next Week

Market Record Highs Belie Volatility Risk of Fed and Central Bank Decisions Next Week

Risk assets have ground higher, taking full advantage of the late summer doldrums while the Dollar has worked its way into an exceptionally narrow range. Will the peace hold through the closely-watched FOMC rate decision?

Talking Points:

• Benchmarks of ‘risk appetite’ – like the S&P 500 – continue to grind higher, but few are reassured by the fundamental backdrop
• Seasonality typically experiences an abrupt change in the 38th week of the year as participation (volume) tends to swell
• A dense run of key event risk and a particularly important FOMC rate decision on Wednesday will pose a serious volatility concentration risk

Seasonality In Activity Level Rather than Direction

There is no mistaking that the week ahead of us is punctuated by a clear, prevailing fundamental theme: monetary policy. It is possible that trade wars can flare up, geopolitical tensions render a surprise spark or a more stoic macro theme (eg slowing growth or eroding fiscal backdrops) finds sudden interest; but those are outliers. If we are following the probabilities, the economic docket is stocked with the kind of event risk that would readily tap into the deeper veins of global monetary policy. A few times a year, there is a confluence of major central bank meetings; but it is infrequent that this planetary alignment happens when risk sentiment is at an extreme and one of the key players is at the threshold of a course change.

S&P 500 and Volume Calendar Week Averages over 100 and 75 Years

  

Source: John Kicklighter, Standard & Poor’s 

A Dense Docket Clearly Split In Focus Before and After FOMC

Historically, the 38th week of the year – which we are entering – is one of the most active according to a seasonal analysis of the benchmark S&P 500. It holds true that past performance is not indicative of future events; but rather than focus on the direction of these norms, considering the participation and activity levels. Direction depends on a competition of many competing factors every year, but the relative level of backdrop conditions tends to diverge far less. As the third highest volumed week for the S&P 500 in an average calendar year (stretching back 75 years) and with a run of known, high-potential event risk, it is worth market participants be on alert.

Calendar of Top Global Macro Event Risk

  

Source: John Kicklighter

 

 

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China’s Struggle with US Trade Has Faded for Yuan But What About the Data?

Looking over the week, there is a pretty clean split in macro focus around the exact middle of the week – particularly Wednesday during the US session. Before that fundamental gear shift, we have a healthy run of traditional economic data. It is worth tracking data points like UK employment, Canadian consumer inflation, US retail sales and Japanese trade; but there isn’t a particular depth to any of these embers. The exception is the run of data that will start us out Monday in the Asian session from China. On the docket, we have Chinese housing prices (1:30 GMT), industrial production, fixed asset investment, retail sales and unemployment (2:00 GMT) all for August.

This is a good reflection on the manufacturing engine, domestic consumption and the still stretched credit market that drove expansion since it carried the economy through the Great Financial Crisis. The market generally takes these data points with a grain of salt, but the series have seemed far less embellished than what has been seen in the past. Notably, the world’s second largest economy has seen its benchmark capital markets (represented by the Shanghai Composite) and its currency (the Yuan) recover steadily despite general economic struggles and the frayed trade relationship with the world’s largest consumer, the United States. Will this data call attention to the state of the markets – for better or worse?

Chart of USDCNH Exchange Rate Overlaid with DXY Dollar Index (Daily)

  

Source: TradingView, ICE Dollar Index 

 

 

 

A Critical FOMC Rate Decision (and Forecast Update)

The top event risk for the week ahead, hands down, is the Federal Open Market Committee (FOMC) rate decision. Due Wednesday at 18:00 GMT, this is a confluence of many potent factors that will raise the threat of volatility and even trend instigation for risk trends at large. First, the ‘routine’ elements of interest for this event: this is the largest central bank in the world that often speaks to the larger conversation of global monetary policy, and it is one of the ‘quarterly’ events. That means that not only are we due the rate decision, brief policy statement and the press conference by the Chairman half an hour later; we are also due an update to the group’s forecasts on growth, inflation, employment and interest rates – via the Summary of Economic Projections (SEP).

Adding to the intrigue, the Fed is heavily expected to cut rates at this meeting, which would mark its first reduction of 2025 against the backdrop of so many of its peers having already eased their own settings. Add to that the charged interest that President Trump’s criticism of the institution has added to the mix. He has been vocal about his belief that the central bank is late and should dramatically reduce rates from their current 4.25 – 4.50 percent range. He has also very transparently attempted to cajole compliance and has had his team find means of replacing ‘data dependent’ voting members with more sympathetic replacements. After the huge downward revision in annual NFPs paired against the stubborn buoyancy of the CPI this past week, everyone will be watching this event closely. Of all the moving parts of this update, however, I will be most interested on the updated forecasts.

FOMC Decision and Dollar / S&P 500 Impact Scenario Table

   

Source: John Kicklighter, CME Federal Fund Futures 

 

 

The Fed Isn’t the Only Central Bank On Tap

As a final focal point of fundamental focus through the week, it is worth separating out the Federal Reserve’s policy decision from its many peers determining the same in the second half of the week. There are a lot of central banks on tap. Less global emphasis will be placed upon the likes of the Brazilian and South African central banks’ decisions; but they are made even more important for their local markets with the contrast of the US update. The Fed will add context to all of the major players setting their own configurations. Before the Fed, the Bank of Canada (BOC) is drawing consensus forecasts from economists that is on the cusp of a hold at 2.75 percent and potentially another -25 basis point (bp) rate cut. The BOC already cut heavily over the past 15 months by trimming -225bps. Could it attempt to offset trade pressure manifest in exchange rates by further tracking its US counterpart?

The following day, the Bank of England (BOE) is expected to hold its key rate unchanged at 4.00 percent. It has spaced out -125bps of easing over the past year, but the economic and financial position in the UK has been able to register limited traction from the support. Heading into the end of the week, we will then have two of the most dovish of the major central banks: the Bank of Japan (BOJ) and People’s Bank of China (PBOC). The BOJ has actually hiked rates multiple times over the past 18 months, but that only brought the benchmark to 0.50 percent. Further hikes are expected as Japan sees tangible, above target inflation; but political turmoil will make a move now very unlikely. Finally, the PBOC’s 1-year prime loan rate is seen holding at 3.00 percent after three staggered cuts since July of last year. While China is still very keen on engineering a recovery between troubled trade conditions and a still immature domestic growth, the fallout from the debt binge of previous years makes monetary policy an unappealing tool.

 

Chart of Relative Monetary Policy Standing of Major Central Banks

  

Source: John Kicklighter 

 

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--- Written by John Kicklighter, Global Head of Content