DJIA threatens to break key resistance as investors price out rate hike

So we had some more disappointing data from the US in the form of CPI today which has basically further reduced the likelihood that the Federal Reserve would hike interest rates tomorrow, and maybe even deliver a dovish message. Consequently, the dollar has fallen, while the buck-denominated commodities such gold, copper and oil have all joined the stock market rally. The big question of course is where do we go from here? Well, that will depend at least to some degree on what the Fed does tomorrow, and my colleague Matt Weller has already gone through the trouble of putting up the various potential outcomes HERE.

As far as equities are concerned, the best outcome would probably be a no rate hike and a dovish message. But as Matt has pointed out, the more likely outcome is probably a hawkish message but no rate increase. In this scenario, stocks may extend their gains a little bit further before potentially selling off again. But at the time of this writing, the Dow Jones Industrial Average was testing a major area of resistance around 16700, so further potential gains at least for this index will depend on whether the bulls will be able to reclaim this area. This is where the previous rallies had stalled over the past three weeks or so. Thus, given the technical important of this level, we wouldn’t be surprised to at least see some profit-taking here or indeed a triple top reversal formation or a false breakout pattern that could precede a sharp sell-off later in this session/week. In this scenario, the bears will then need to take out some short-term supports such as 16650 and 16570 before we could see a pronounced move lower. The more significant level of support is around 16300 and if that also breaks then the potential sell-off could accelerate.

However should the bulls win back the control here and the index breaks decisively above the aforementioned 16700 resistance level, we could easily see the rally extend over the coming days to at least the next potential resistance at 17040, a level which was formerly support. Beyond that level, the next major resistance could be in the range between 17150 and 17275. As can be seen from the chart, the lower end of this range marks the convergence of the 50-day moving average with the 61.8% Fibonacci retracement level of the downward move from the all-time peak of around 18365, while the upper end was previously resistance. If the potential rally does not stall here, then there is little further resistance seen until all the way around 17700. The latter is where the 200-day average converges with the 78.6% Fibonacci retracement of the abovementioned swing.

But regardless of what the index does in the immediate term, some of the longer-term technical indicators have turned bearish. The 50-day moving average, for example, has crossed below the 200 to create a so-called “death cross,” and more significantly a bullish trend that went back all the way to March 2009 has been eroded. When the moving averages are in this particular order, some momentum traders would be looking to sell the rallies rather than buy the dips. So, it could be that the top has already been formed.  Indeed, when long-term trends change, it is very common for the markets to stage deep retracements. This is because most people will still be looking for trades that had worked well in the past: “buying the dips,” in the case of the Dow and other major indices. These rebounds progressively get shallower and eventually the pressure gets too much and the long-term trend reverses. But the million dollar question of course is: are we there yet? Has the market already topped? In our view, a closing break above the 200-day moving average would once and for all end this long-term bearish outlook. But until and unless we see that, we remain sceptical about this rally even if further short-term gains are witnessed.