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S&P 500 & Dow Jones Forecast: Fed Balance Sheet Key to Outlook

S&P 500 & Dow Jones Price Analysis & News

  • S&P 500, Dow Jones Under pressure from Coronavirus Fears
  • Federal Reserve Balance Sheet Contraction Would Pose Downside Risks

S&P 500: Declines in the S&P 500 at the beginning of the week had temporarily come to a halt amid support from 3224 (23.6% Fibonacci retracement). However, with the index failing to make a break back above the psychological 3300 level, the outlook remains cautious given the continued uncertainty pertaining to the spread of the coronavirus.

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That said, a key factor to bear in mind, is the Federal Reserve’s balance sheet. Since mid-October the central bank has been purchasing US treasury bills at a monthly rate of $60bln, while also injecting liquidity via repos. In turn, this has coincided with sizeable stock market gains, which had been echoed by Fed’s Kaplan, who stated that the central banks actions are driving up risk taking. Earlier this week, the Federal Reserve reiterated that it plans to curtail balance sheet expansion by spring, thus potentially taking away a notable driver for the stock market. Astute eyes would have noticed that growth of the Fed’s balance sheet has slowed recently.

Contraction in Fed’s Balance Sheet to Pose Downside Risks to Equity Markets

Federal Reserve Balance Sheet vs S&P 500

S&P 500 Price Chart: Daily Time Frame

S&P 500 Price Chart

Source: IG Charts

Dow Jones:With the Dow Jones failing to reclaim 29,000, the index remains at risk of a pullback. However, a firm break of 28,700 would be needed for a more corrective drop towards the January 8th low of 28,121. Aside from external factors focus in the near-term will be on a raft of US data, including ISM and NFP. The Federal Reserve are likely to maintain its policy stance in the short-term, therefore, greater attention is likely to center around the US ISM Manufacturing data. The recent upturn in regional survey’s signal that the ISM PMI should see a rebound, which in turn could see modest easing in selling pressure.

Dow Jones Price Chart: Daily Time Frame

Dow Jones Price Chart

Source: IG Charts

— Written by Justin McQueen, Market Analyst

Follow Justin on Twitter @JMcQueenFX