Fed rates and S&P 500 analysis: A short window to rebound?

28 Jul 2022

Following the Federal Reserve meeting, which delivered a back-to-back 75-basis-point rate hike to 2.25-2.5% (USINTR), S&P 500 index broke above 4,000 points, marking a 2.6% daily gain, as market expectations pointed to a halt in rate hikes at the end of the year, and a rate cut in the first half of next year.

A window for a "bear market rally" in the S&P 500 could be the case between now and the next September meeting if upcoming economic data indicate a peak in inflation and a weakening labour market. This would bolster the Federal Reserve's soft-landing goal and keep short-term interest rates in check.

First of all, the market is repricing the fear of an impending recession, as the earnings season continues to produce positive results. Second, given the recent negative correlation between short-term rates and the S&P 500 index, a stabilization or even a decline in short-term 2-year Treasury yields would provide further oxygen to the stock-market rebound.

Momentum indicator (14-day RSI) has been hovering above 50 for the past week and is now pointing northward, indicating that bulls are gaining the upper hand in the short term.

4,160 is a short-term technical resistance at the May/June peaks and March 2022 support. A break above this level would pave the way for a 4,300 target (4 May high). A rise to 4,500 (21 April high) seems to be more challenging at this stage.

The alternative scenario, in which inflation data remains higher than expected and Fed representatives remain extremely hawkish, might portray a pullback in the 3,800-3,720 region. However, to revise the S&P 500’s year-to-date low (3,639), it is appropriate to witness a new "rate-shock", with short-term Treasury yields spiking above 3.4-3.5% in response to a Federal Reserve's aggressive tightening bias.