The S&P 500 and Nasdaq Composite shot back up to new record highs on Friday on the strength of more major earnings beats and just three trading days ahead of the potentially pivotal Federal Reserve meeting next week. Investor sentiment remains strongly bullish as markets prepare for what will very likely be the first Fed interest rate cut in more than a decade.
The real question for investors now is not whether the Fed will cut rates next Wednesday, but by how much. Will it be by 0.25% or 0.50%? Though it may seem like a relatively small difference, the implications of that difference are highly significant for companies and markets. For the most part, the stock market generally likes lower interest rates, and the expectations of falling rates has been one of the primary drivers of new record highs in stocks.
But the rationale behind lowering interest rates has come into question recently. The Fed has maintained that cutting rates, or monetary easing, will be necessary to mitigate the effects of a softening economy, trade war effects, and lagging inflation, among other key economic risks.
However, recent data has not supported the Fed’s primary concern of slowing economic growth. In July alone, key data releases including jobs growth, manufacturing, retail sales, and durable goods orders have all come out better than expected. And from the latest release on Friday, even though gross domestic product (GDP) growth slowed in the second quarter from the first, it was better than expected at +2.1%. All of this leaves Wednesday’s Fed decision still pretty much up in the air in terms of the magnitude of the potential rate cut.
Still, markets were unperturbed on Friday, as the benchmark S&P 500 index surged a full 0.74%. The chart of the S&P 500 shows the recent climb to progressively higher all-time highs and the latest breakout above a key pennant consolidation pattern. Any continuation of the rally after next week’s Fed decision has the potential to boost the index toward its first major upside target in uncharted territory around 3,090, which is near a key 161.8% Fibonacci extension level.
Earnings Impress (Mostly)
Major corporate earnings beats that helped propel stocks to new highs on Friday included Alphabet Inc. (GOOGL), Twitter, Inc. (TWTR), and Starbucks Corporation (SBUX), all of which gapped up and spiked more than 9% on their better-than-expected results. Amazon.com, Inc. (AMZN) fell short and dropped, but not by enough to offset the big gains in other major stocks.
Here’s a chart of Alphabet, which not only beat earnings forecasts, but also just announced a $25 billion share repurchase plan. With the gap up on Friday and nearly 10% surge, the stock may soon approach major resistance around the $1,295 level, which represents the April all-time high and a key retest of the July 2018 high. That resistance is both the next major target and a potential barrier to further gains.
U.S. Dollar Extends Rally
Aside from stocks and bonds, the U.S. dollar will be in focus as we approach Wednesday’s Fed decision as well as the key U.S. jobs report at the end of next week. This past week, Trump reportedly discussed the issue of the strong dollar with key advisers.
Indeed, the dollar has been noticeably strengthening of late, even in the face of declining interest rate expectations. Recent positive U.S. economic data has helped boost the greenback, but it remains to be seen how the Fed’s decision next week will impact it. In the less probable event of a 0.50% rate cut, the dollar is very likely to fall. But a 0.25% cut is probably already priced-in.
Below is a chart of the U.S. dollar index, which is a benchmark pricing mechanism that compares the dollar to a basket of other major currencies. The dollar index is clearly strong and re-approaching two-year highs. But major resistance is immediately to the upside around the 98.37 level, which represents the May high. Currently, the dollar index continues to be heavily overbought technically and should be poised for a fall from its highs, especially with any dovish decision from the Fed next week.
The Bottom Line
We’ve been discussing the Fed a lot (maybe too much) lately, but for good reason. The FOMC meeting and decision in the week ahead will almost certainly be a substantial market mover. Whether you’re looking at stocks, bonds, currencies, or commodities, the Fed will be the primary focus.
Of course, we’ll also have many other major earnings releases, an expected re-start of U.S.-China trade talks, and the key U.S. jobs report. But if you’re looking for one factor that has the potential to set market direction in the near term, look no further than the Fed.
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