The U.S. stock-market rally is on an “unsustainable” near-term trajectory, leaving it vulnerable to a pullback Wednesday if the Federal Reserve, as expected, holds interest rates steady, a top Wall Street technician warned.
“Markets are on a torrid pace this week in anticipation of a Fed pause today. We suspect it to be a classic sell the news event, as the trajectory has become near‐term unsustainable,” said Jeff deGraaf, chairman and head of technical research at Renaissance Macro Research, in a Wednesday morning note.
DeGraaf, who remains bullish on the market overall, is referring to the popular trading adage, “buy the rumor, sell the news.” It holds that markets rally in anticipation of a positive event, then tend to pull back after the event occurs because it has already been priced in.
The Federal Reserve is widely expected to leave its fed-funds rate at 5% to 5.25% when it announces the outcome of its two-day policy meeting at 2 p.m. Eastern. That will mark the first pause since the central bank began aggressively lifting rates from near zero in March 2022.
Fed Chair Jerome Powell will hold a news conference at 2:30 p.m.
Fed-funds futures traders have priced in a roughly 60% chance of another 25 basis point rate increase in July, according to the CME FedWatch tool.
Market expectations for a pause, followed by perhaps one more hike, have been credited with a rally that saw the S&P 500 post a 4.5% month-to-date rally, with the large-cap benchmark last week exiting its longest bear market since 1948. The S&P 500 and Nasdaq Composite on Tuesday ended at their highest since April 2022. The Dow Jones Industrial Average has gained 4% so far in June.
Stocks were in a holding pattern Wednesday ahead of the Fed decision.
Meanwhile, the put/call ratio — a gauge used to measure trader sentiment toward the market — has fallen, signaling increased optimism. Puts are options that give the holder the right, but not the obligation, to sell the underlying asset at a set price by a certain date; calls are options that allow the holder to buy. Extreme readings are viewed as a contrarian indicator.
“The put/call ratio has contracted, but not to dangerous levels, but enough to warrant some sobriety,” deGraaf said (see chart above).
The biggest risk to RenMac’s bullish market call comes from nominal Treasury yields, he said.
The 10-year Treasury yield stood at 3.778% on Wednesday morning. It traded below 3.3% earlier this year, after peaking last year above 4.2%. A sharp spike in yields last year as the Fed tightened monetary policy accompanied last year’s bear-market selloff in stocks.
DeGraaf said somewhere above 3.85% is where history shows that yields have statistically started to undercut forward returns for the S&P 500 companies.