For some reason the stock market tends to rally into the FOMC announcements and some are anticipating a post-FOMC rally following the first rate increase since 2006. The question now is whether the market is setting itself up for a buy the rumor, sell the news reaction on Thursday.
Today's Market Stats
It's been documented, even by the Fed, that the stock market tends to rise into the FOMC announcement, which is what we're seeing this week. There's also a common pattern for the market to rally, even if only for a few days, following the first rate increase, which apparently many traders are betting on. There's also the fear factor from the shorts, who do not want to be part of a short squeeze in the event of a rally following the FOMC announcement and their covering could be fueling this week's rally. Short covering could of course leave the market vulnerable to a stronger post-FOMC selloff since sellers of long positions would be joined by all those who want to be short piling back in. It could be an interesting time following Thursday's announcement.
The only economic report of importance this morning, particularly for the Fed and their "data" dependency for making rate decisions, was the CPI data for August. It came in as expected -- -0.1% for CPI (vs. +0.1% in July) and +0.1% for core CPI (the same as July). It was market neutral and futures barely reacted to the pre-market report.
We are at an interesting point in the market with the Fed. Up until recently we've seen the market react negatively to any hint of a rate increase, primarily because the market has been afraid it can't stand on its own two feet without the Fed's help. But with the constant barrage of Fed heads saying they need to start the ball moving toward higher rates, that it will be minimal, etc., the market has essentially accepted it and wants to get it over with and move on. Removing the uncertainty of it could get the market unstuck and start another rally leg.
But the other side of the argument is still there -- if the Fed becomes less accommodative it could start to negatively affect the market. Since the Fed stopped purchasing $85B/month in Treasuries, in October 2014, we've seen the market trade sideways. Prior to the strong selloff in August the DOW was where it was in September 2014 and is currently negative a year later. If the Fed now starts raising interest rates it could put a further damper on the economy (although it's hard to see how a 0.125% or 0.25% rate increase could have much effect). So the bottom line is we really don't have a clue how the market will react to Thursday's rate decision or what Yellen might say after the announcement, no matter which decision they make.
So we stick with the charts and make our best guess based on what we see there. At least we can determine where we see an acceptable risk:reward setup, take the trade and then manage it appropriately, which for most traders means where to place your stop (where the market proves your assumption is wrong and to then get out of the way). We've got some interesting setups as of Wednesday's close and what happens on Thursday could finally answer some short-term direction questions.
The DOW's weekly chart shows it has bounced back up near its broken trend line along the highs from 1971-1972-1987. The DOW had climbed above this line in March 2013 and then used the line for support multiple times, the last being the October 2014 low. This is one reason why the break below the October 2014 low, into the August 24th low, was so important -- it confirmed the break of this important long-term trend line. The line is currently near 16800 so from today's high at 16756 there's still a small upside potential (and of course the line marks a general price area). The bulls need to get the DOW above 17100 in order to make it look like something more bullish than just a bounce correction to the decline. The bears need price back below the August 30th low near 15980 in order to confirm the bounce off the August 24th low is just a correction to the decline.
Dow Industrials, INDU, Weekly chart
Anyone who knows how to draw lines on a chart has been tracking a triangle pattern for the DOW's bounce off the August 24th low, which is what I too have been tracking and is shown on the daily chart below. Today's rally, especially with the push higher in the final 30 minutes (short covering?), pushed the DOW above the top of the ascending triangle, near 16670. A close above 16670 left it bullish but only if the bulls can hold it above that level on Thursday otherwise it will look like a 1-day head-fake break. With so many watching this pattern, short covering following the rally above 16670 is a very likely possibility and it might not hold tomorrow. I show a breakdown from here because the triangle pattern, if left intact, is a bearish continuation pattern following the selloff. But a failed pattern tends to fail hard so a continuation of the rally should have bears backing away. A rally could run into trouble at the downtrend line from July-August, near 16995, price-level resistance near 17067, and then its 50-dma, near 17158 on Thursday.
Dow Industrials, INDU, Daily chart
Key Levels for DOW:
- bullish above 17,100
- bearish below 15,980
The ascending triangle pattern is shown more closely on the 60-min chart below, including today's pop above the top of the triangle. These patterns often finish with a small throw-over, which could be what today's finish was. An immediate drop back down is needed by the bears otherwise we could see a continuation higher into next week, especially if a pullback finds support at the top of the triangle (as it did late today), shown with the green dashed line.
Dow Industrials, INDU, 60-min chart
SPX has the same triangle, the top of which is near 1994 and that too was exceeded with today's close at 1995. It stays bullish above 1994 but bearish below 1950. The pattern would be confirmed bearish below the September 1st low near 1903. The bulls have a shot here though, as I'll show on the 60-min chart further below. Notice MACD has bounced back up to the zero line from deeply oversold. A rollover from the zero line here would create a strong sell signal, something I'll be watching carefully over the next few days.
S&P 500, SPX, Daily chart
Key Levels for SPX:
- bullish above 1994
- bearish below 1903
It's possible the sideways triangle since the August 28th high is a b-wave triangle in what will become a larger A-B-C bounce off the August 24th low. As depicted on the 60-min chart below, a drop back down to about 1965 could set up a strong rally to 2090-2100 before reversing back down. That kind of move would completely whip both sides and perversely is probably the reason we'll see something like this (wink). Either that or a deeper decline, maybe 1900, to complete the b-wave before the strong c-wave rally and then a stronger decline. The reason for showing the different pattern on the SPX 60-min chart vs. the DOW's 60-min chart is to make you aware that we could see some big moves over the next week but they might be reversed hard. I can only show the possible moves and then wait for price to show us which one is more likely. This is a tough spot for a trader to take a position and it's one reason why it could be a good idea to say "I'll pass" and wait for the next opportunity.
S&P 500, SPX, 60-min chart
With today's high near 4388 NDX made it up to its broken 200-dma, at 4384.69, and it closed its August 21st gap down, at 4385.13. It could turn into a back-test that will be followed by a reversal back down and a red candle for Thursday would leave a bearish play against today's or tomorrow's high. But as long as NDX stays above 4385 it will stay bullish.
Nasdaq-100, NDX, Daily chart
Key Levels for NDX:
- bullish above 4385
- bearish below 4121
The RUT drove right up to resistance today at 1175, which is where it closed. Its downtrend line from July-August and its broken uptrend line from October 2011 - October 2014 cross near 1175 today (arithmetic price scale) so it would obviously be more bullish above that level. Interestingly, today's potential back-test of the broken 2011-2014 uptrend line is essentially the 3rd one since the August 26th low, which sets up the potential for a 3-drives-to-a-high topping pattern. The bounce off its August low looks like a choppy correction to the decline rather than something more bullish. That can change quickly but at the moment, what I see on the chart is a bounce pattern to resistance begging to be shorted.
Russell-2000, RUT, Daily chart
Key Levels for RUT:
- bullish above 1175
- bearish below 1124
Treasury yields have spiked up this week and it's looking like the bond market is telling us the Fed is going to raise rates. But from a chart perspective TNX (10-year yield) could be setting up a reversal back down, which says the Fed will not raise rates. It has rallied up to its broken uptrend line from January-April, currently near 2.3% (today's high was 2.296%). Also, the bounce off the August 24th low is a 3-wave move and the 2nd leg of the bounce is 62% of the 1st leg at the same 2.3%. Disregarding the FOMC announcement, this setup is an "automatic" short. A down day on Thursday, following today's back-test and small doji at resistance, would be a sell signal. But a continuation of the rally, especially above 2.32% would be bullish. Since the stock market and Treasury yields are more often in synch than not, it will be important to watch bonds over the next few days.
10-year Yield, TNX, Daily chart
There's not much to add for the dollar this week since it has barely moved. If the Fed raises rates it would likely rally the dollar, in which case watch for resistance at its downtrend line from March-August, near 97.80. If the dollar drops I'll be watching for support near its 50-week MA, near 94, and the top of its parallel up-channel form 2008-2011, near 93.80, which it had climbed above in January and is now using as support.
U.S. Dollar contract, DX, Weekly chart
Like the dollar, gold hasn't moved much this week and is currently trapped between price-level resistance near 1142 and Fib support (50% retracement of 2001-2011 rally) at 1090. I can see the potential for a rally up to about 1195 (two equal leg up from its July 24th low) to finish a bounce correction before continuing lower but a drop below its July 24th low at 1072.30 would confirm the bearish trend remains intact, which is what I'm currently thinking.
Gold continuous contract, GC, Weekly chart
While the stock market indexes have been consolidating in ascending triangle patterns oils was consolidating in a descending triangle (flat bottom, declining tops) and broke to the upside yesterday. It's looking like the bounce off its August 24th low should continue, which is what I've been projecting for a sideways triangle consolidation pattern into next year. A rally in oil is supportive of a rally in stocks so this one is a heads up to bears to be careful.
Oil continuous contract, CL, Weekly chart
Tomorrow's economic reports include housing starts and permits for August, which are expected to be roughly the same as July. After the opening bell we'll get the Philly Fed report for September, which is expected to show a slowdown from August. The big report will of course be the FOMC announcement at 2:00 PM.
Economic reports and Summary
While we can't know how the market will react to the FOMC announcement we can at least watch for some clues from the charts and the key levels I've identified with the chart patterns. From a time-cycle perspective, September 16/17 is a turn window based on a 40-day cycle that has marked previous turns. Rallying into the current window suggests a reversal back down and a strong selloff on Thursday into Friday would suggest. But as shown on the charts, we have no clear setups at the moment, except for a short play if the market reverses back down in the morning. The trouble is holding a position over the FOMC announcement, always a dicey proposition.
The bottom line is we could see some big price swings in both directions before the market settles on a direction. This could be exacerbated by opex and therefore caution is required if you step into the waters tomorrow and Friday. As traders we try to catch the turns and play the momentum but it's been a choppy mess lately and that might not change this week. Flat is a position while waiting for a direction to better identify itself and while I lean bearish this evening, this market has a nasty habit of showing me why I'm wrong. We'll soon find out.
Good luck and I'll be back with you next Wednesday.
Keene H. Little, CMT
In the end everything works out and if it doesn't work out, it is not the end. Old Indian Saying