Tuesday, April 26, 2016

What happens if the Fed gets less dovish?

Mid-week market update: There doesn't seem to be much of a point in writing about the technical condition of the market when its likely path is dominated by a binary event like the FOMC meeting this week. So I thought that I would write about how to interpret and react to the FOMC statement instead.

Much of investing is about setting a course of action and assessing risks under different scenarios. A key assumptions of my equity bull case that I made on the weekend is a relatively equity friendly Federal Reserve (see How the SP 500 can get to 2400 this year). As we approach another FOMC meeting, a key question is, "How do we react if the Fed gets more hawkish?"

Poised for a hawkish rebound?
Despite the dovish tilt of the Yellen Fed, BCA Research pointed out that the Fed seems to go through a stop-start hawk-dove policy loop - and we are currently nearing a dovish extreme.A reversion to a more hawkish tone in its communications would therefore be no big surprise.

From a technical perspective, the markets are also ripe for a reversal. The USD Index, which is a key indicator of monetary policy divergence and driver of US corporate earnings growth, is currently testing an important support level.

Hedge funds have reversed out of their crowded long in the USD and they are now slightly short.

The flip side of the USD weakness coin is commodity strength. The post child of commodity strength are the precious metals and Tiho Brkan pointed out that gold miners are now highly overbought:

...while hedge funds are in a crowded long position in silver:

A less dovish message from the Fed this week has the potential to embolden dollar bulls and panic commodity bears.

The full post can be found at our new site here.

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