Equity market expects Fed to delay tightening; bond players don't buy it

The equity markets have rallied past a few resistance levels clearly expecting the Federal Reserve to delay its monetary tightening. The Sensex and Nifty burst out of resistance and seems headed to the all time high. The same looks true for the S&P 500 and Dow.

Last week the US employment numbers came in below expectations and the numbers of the previous months were revised down. This raised hopes in the equity markets that the Federal Reserve will delay the winding down of the quantitative easing program. Consequently we had a rally in the Indian as well as US markets.

The bond markets on the other hand have not rejoiced. A look at the 10-year US treasury (UST) shows that the bond is hovering near a support level and not rallied. (Click here for the UST chart). A look at the combined chart (Click here for the chart)of the Sensex and Nifty shows that strong rally. The first day the Indian markets could trade after the announcement of the employment report was on Tuesday. Both Nifty and Sensex gapped above the resistance zone and rallied up. This showed strong bullishness. A gap happens when the price closes at one level and opens much higher or lower on the next trading day. Prices gap is higher due to lack of supply of stocks at lower levels.

U.S. Federal Reserve Building is pictured in Washington

If the Federal Reserve indicates that tightening will not happen soon, we can see both bonds and equities rally.

The worrying fact for the equity market is that bond markets are not giving any indication that it believes the tightening will be postponed. The bond markets are often more mature and correct about the future. They say equity players are teenagers and bond markets are the granddads. The Federal Reserve makes its policy announcement on Wednesday in the US and market reaction will give us an indication of the future.

If the Federal Reserve indicates that tightening will not happen soon, we can see both bonds and equities rally. However, any indication that the tightening will be implemented as scheduled is a negative for both the equities and bonds. Remember that the UST is at support which has to be broken for it to fall further. If the bonds break support, the fall in equities can be brutal as it has had quite a run up over the past few days. Also Sensex and Nifty are nearing strong resistance zones, which puts additional bearish pressure, if bonds break.

The Indian indexes are also nearing a resistance zone which is level of the all time high. This is a very high area of supply and the index could not break it a few times earlier. However, this is the third time that the indexes are testing all time high. The more times a resistance is tested the more likely it is to be broken.

The support levels are shown on the chart with blue horizontal lines and the resistance levels are shown by red lines.

The market to watch during the middle of the week is the UST. They will give a sense of the future direction of the global financial markets.

Firstpost is now on WhatsApp. For the latest analysis, commentary and news updates, sign up for our WhatsApp services. Just go to Firstpost.com/Whatsapp and hit the Subscribe button.

Updated Date: Dec 21, 2014 03:39:07 IST

Also See