Get ready for a stampede of Fed speakers this week to warm up the crowd for Jay Powell’s speech at the Fed FOMC policy meeting on Feb. 1.
The nearly 7% SPX rally to start the year is not what the Fed wanted or needed in its quest to crush inflation.
The Fed is intensely focused on the stock market because higher stock prices negate the tightening of financial conditions that the Fed is orchestrating.
In fact, this rally has moved the National Financial Conditions Index to its lowest levels in the past five months.
Today, we’ll look at why this may be a good time to buy the dollar in anticipation of the Fed once again tightening the screws on financial conditions.
The Fed’s Dilemma
What will Powell do? He has higher stock prices to contend with, which eases financial conditions and could put an end to the progress he has made on inflation.
Check out the Goldman Sachs financial conditions index versus the Fed rate hiking
cycle below …
The red line is the Fed rate hikes and the blue line is the GS financial conditions index. When the index is dropping it signals an easing in conditions.
Notice how conditions are back to the easiest they have been since August (green dotted line). J-Pow certainly hasn’t had success just talking the market down lately.
However, there is something the Fed can do …
Powell could increase the amount of money he drains from the system, which would directly tighten conditions and send stocks lower.
More QT Could Get the Job Done
Quantitative tightening (QT) directly drains money from the financial system by forcing banks to buy securities from the Fed.
The Fed has already drained $52 billion from the markets in January after just two weeks. At that pace he could ignite a reversal …
This additional tightening, plus option expiration on Friday, could reverse the stock rally and send the dollar trending down – which would help the Fed into the policy meeting.
What’s the Trade?
I like playing for a correction in stocks and the dollar via a bearish strategy in the euro. You can use the Invesco Euro Currency Trust (Ticker: FXE) to express this trade.
On Tuesday, FXE tested the largest open interest $100 strike and failed in a big way, forming a bearish engulfing pattern and triggering a negative price/RSI divergence. See below …
Bring It Home
Failing at the 100 strike should trigger a move to the 98 gamma pivot strike by the Feb. 1 FOMC meeting.
I will consider a 99.5/98 put spread to Feb. 3, with a cost of $.50 per contract.
This is a good low risk/high reward trade. Plus, the Jan. 20 monthly expiry may ignite a correction in FXE, which will have a large amount of calls expiring.
The expiring calls will force option dealers that sold the calls to sell their short stock delta hedge against the position, fueling a reversal in price.
When fundamentals meet technicals the probability of success rises, which doesn’t guarantee a winner but does give you an edge.
Live and Trade With Passion My Friend,
Griff