The US stock market continues to retrace from its highs that it achieved last month. We are not only witnessing a retracement in the stock market, but we are also witnessing a retracement in gold prices today, as traders are taking calculated risks ahead of the crucial economic event that is set to unfold later this week. The economic event holds significant importance for the US stock market, which has started the month under pressure due to traders’ belief that the market has risen too quickly and too far. For instance, if one looks at the S&P500’s gains year-to-date, they are in double digits, which many find simply insane, especially considering the stellar performance the index posted last year.
As for the precious metal, the path of the least resistance appears to be following a skewed path of least resistance towards the upside, characterised by more gradual moves. The yellow metal’s prices are more than likely to continue to consolidate ahead of the US NFP event, as investors want more clarity before going big.
Background
The US stock indices recorded stellar performance during the last month, with all of them closing higher by more than 2%. The S&P 500 index is up nearly 11.4% so far this year; the tech giant’s Nasdaq 100 index has scored gains of 12%; and the Dow Jones industrial average has soared over 2.2% year to date.
Most companies have already announced their earnings, so traders and investors are confident that CAPEX spending is still strong and companies aren’t hesitating to invest more, which means that the US economy could experience higher GDP growth and a stronger employment market.
Given the performance of the US stock indices thus far, as previously mentioned, one may naturally question why the Dow Jones Industrial Average hasn’t outperformed the other indices. The simple answer is that investors have found it challenging to understand the conflicting messages from the Fed members. Over the past few weeks, we have received mixed messages from the FOMC members, with some suggesting that the prospects of further rate hikes may not be imminent. These hawkish members continue to argue that inflation in the country is running hot and that it is acting highly stubborn. These hawkish members maintain their belief that inflation will likely take another year to reach the Fed’s targeted 2% level, and if the Fed aims to reach this level earlier than expected, they may need to consider another interest rate hike. Their commentary has certainly made equity traders a lot more cautious.
Having said this, Jerome Powell, the Chairman of the Federal Reserve, hasn’t indicated a serious need for another interest rate hike, which is a welcome development for many traders, as the market players tend to favor dovish language. In his most recent commentary, he attempted to convey a subtle message to traders. Investors are aware that the US economy remains robust, indicating that the risk of a hard landing, which many economists have been advising against, is minimal to non-existent.
The focal point
Many speculators argue against the above point. They argue that traders should exercise caution when engaging in riskier wagers, not only due to the rapid growth of the US stock market but also due to the emergence of signs of weakness in the US labor market. Consequently, traders view the forthcoming US NFP data, scheduled for release on Friday at 13:30 UK time, as crucial. This is because it would provide a detailed picture of the US labour market, and in previous prints, there were clear signs of weakness due to a lower reading than many anticipated.
The US NFP’s Trading Game
As mentioned above, on Friday, we have the most important economic report coming, which will dictate trading not only on that day but also set the trend for the remaining month. The report that traders are eagerly waiting for is the US NFP data, and the expectations for this report are 189K, while the previous number came in at 175K.
Now comes the trading game plan. If the report comes in much softer than anticipated, it would be very much like a case where bad news is good news and good news is good news. What we mean by that is that if the number comes lower than expectations, traders would expect less hawkish commentary from the Fed, as they can’t simply afford for the economy to go downhill. We would be looking at a possible interest rate cut that could take place before September.
If the report is good enough, then traders will have fewer things to worry about because they will understand that the Fed can actually increase the interest rate without hurting the economy. All of this would mean that the stock market could actually go much higher than the current anticipation.
The Price Action
For the coming Friday, there are a number of price levels that we think traders need to pay close attention to. Firstly, if the bad news is good news, meaning the data comes in less than expected and traders expect that the Fed will cut rates, that will bring bulls into the market. Under that, the US 500 index, the S&P 500, would move higher and towards the resistance zone—the red line shown on the chart. On the other hand, if there is evidence of a robust labor market, the market may continue to move upwards towards the resistance zone. Another scenario that traders should consider is if the report is positive and they start to fear that the Fed might raise interest rates to control inflation. In such a scenario, we would expect the US stock indices, specifically the S&P 500 index, to decline towards the support zone, also known as the green line.
