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Possible 10% volatility in S&P 500 on Fed pivot bets

Fed

In October, strong optimism has been priced in ahead of the upcoming Federal Open Market Committee (FOMC) decision on Thursday, with the S&P 500 up 10% from its October low.

But have the stock markets hit their bottom? The answer has got a good chance of “yes” at least from a near-term view, if the Fed does pivot or dial back on its rate-hike pace. Let us make the conclusion easy by visualising the correlation between the VIX and S&P 500. 

Source: TradingView as of 02 Nov 2022 (Click to enlarge the chart)

The CBOE Volatility Index (VIX) is now sitting around 25, dropping from above 30 in September, suggesting there are strong bets on the Fed to slow down its tightening pace on monetary policy in the upcoming announcement. The correlation shows that when VIX drops from 32 to 20, the S&P 500 rose 9-10%, when VIX drops from 32 to 15, the S&P 500 rose 20-22%. The S&P 500 has gone up about 10% since the October low, hence, it may encounter another 10% rally, to about 4,200 if the VIX continues to fall from the current level to 15. But please note that this is based on an assumption that the Fed does meet expectations to pivot its speed on rate hikes from December.

On the flip side, a disappointing Fed may reverse the current bullish momentum in the S&P 500, and send the index down another 10%, to its October low around 3,500 and the VIX may spike to above the 30-mark again.  

Another indication that we can read from the above chart is that the VIX usually surges to above 50 when there is a financial crisis during the pandemic in 2020, and the GFC in 2008. But it is unlikely to happen in the near term from the recent VIX movements, and VIX usually finds support around 20 and 15, which requires close attention when it touches these levels.

S&P 500 daily chart

Source: CMC Markets NG as of 02 Nov 2022 (Click to enlarge the chart)

In a near-term view, the S&P 500 faces resistance at the 100-day moving average (MA) of around 3,900, the index shows reluctance to carry on its multi-week rally ahead of the Fed decision day, with short-term support around 3,800 anchoring around the 23.60% Fibonacci retracement. A bullish breakout of the 20-day MA may take the index to further head off to the 4,000 mark at the descending trendline, then 4,150, which is the September high, confluence with the 50.00% Fibonacci retracement. 


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