Fed Tapering Announcement Should Not Surprise Markets

 |  Includes: EEM, EFA, SPY, UUP
by: Chris Ciovacco

Living Under A Rock

The Fed has been telegraphing "tapering" to the markets since late May, or for over four months. Unless you live under a rock, you are well versed on the concept of a Fed taper, which means few should be caught off guard if the announcement comes next week as expected. From The Wall Street Journal:

A majority of economists surveyed by The Wall Street Journal - 66% of the 47 who responded - expect the Federal Reserve to say at next week's policy meeting that it will begin cutting back its bond purchases, a widely anticipated milestone in a period of extraordinary monetary policy. "The weight of evidence on the labor market, and growth more generally, is positive enough for Fed officials to at least start the tapering process at this month's meeting," said Jim O'Sullivan of High Frequency Economics. "One weaker-than-expected employment report…does not offset all the other, more positive news."

The Reemergence of Risk-On

The stock bulls have quietly regained their footing and are trying to nail down an improving look on the weekly chart of the S&P 500 (NYSEARCA:SPY) below. The chart illustrates the base concept of trend following. Once the weekly trend is established, the odds of bullish outcomes increase. The present day (point C) has a promising look, but traders still have to get through Friday's session.

Retail Sales Should Set Tone

Economic data will be closely scrutinized with the Fed's date with tapering destiny just a few trading days away. From Thursday's Washington Post:

The asset purchases are widely credited with holding down interest rates and breathing life into stock markets, and the investment terrain will likely endure a shake-up if and when the Fed announces a "tapering" of asset purchases. That could take place as soon as next week's meeting. The retail sales data for August, which the U.S. Commerce Department will release Friday, will help traders evaluate the likelihood of such an announcement by the Fed.

Dollar Sees Conservative Taper

While the Fed's announcement does not arrive until next Wednesday, the heavily impacted U.S. dollar (NYSEARCA:UUP) is not demonstrating a heavy bias in either direction. From Reuters:

The dollar index which measures the greenback versus a basket of six currencies, fell 0.1 percent to 81.455, having hit a two-week low of 81.356, the weakest since August 28. Markets have tempered their expectations for any aggressive stimulus withdrawal by the Fed. That has led investors to trim long dollar positions built on expectations the Fed will unwind or 'taper' its $85 billion monthly bond purchases by a much larger amount. "It looks like the Fed will only make a modest $10 billion tapering next week. So investors are adjusting their positions accordingly," said Jane Foley, senior currency analyst at Rabobank. "The Fed will be very careful with tapering and will probably only dip its toe."

The dollar and financial markets in general seem to be gravitating around the "small taper" theory, which means a larger than expected taper could be taken as an outlier event.

Investment Implications

We made no changes Thursday. Our market model is highly dependent on weekly readings, which means the reaction to Friday's retail sales could alter what has been a bullish week. The market is still treating 1680-to-1685 as an important bull/bear battleground.

If the bulls can print a weekly close above 1685, we will be much more open to making another incremental addition to the equity side of our portfolios, which includes broad U.S. exposure and some newcomers on the foreign (NYSEARCA:EFA) and emerging markets fronts (NYSEARCA:EEM).

Disclosure: I am long SPY, EEM, EFA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.