It's Fed day. Here are two big questions for markets from a trading veteran.

It’s Fed day. Here are two big questions for markets from a trading veteran.

It’s fair to say that some froth has come out of the market in fear of a tighter Fed. The Nasdaq Composite
COMP
has retreated 5% from its record highs, bitcoin
BTCUSD
has slumped 29% since November, and the Ark Innovation ETF
ARKK
is down 41% from its February peak.

As the Federal Reserve decision looms, there are two big questions facing markets, according to Brent Donnelly, the president of Spectra Markets and a veteran trader. The first, he says, is whether the U.S. economy can survive more than three interest-rate hikes. Right now the market is saying no, judging by how flat the Eurodollar curve is, but the question won’t be answered until data from the first quarter of 2022 arrive.

(Former Treasury Secretary Larry Summers is asking a similar question, as he frets the Fed won’t be able to engineer a soft landing.)

The other big question, which also won’t be answered today, is whether stocks can survive the start of Fed tightening, Donnelly says.

Donnelly says the conventional wisdom is that the early stages of the Fed cycle are bullish for stocks, and there are buying opportunities when markets get too anxious. He says the reality is there are normally two waves of equity fears, “and unless you have a 2+ year time horizon you can’t ignore the first one.” The second leg is when the Fed moves into restrictive territory and a bear market ensues. “We are in wave one,” he said.

The current economic cycle, he says, is on “hyperspeed,” and the current state of macro is reminiscent of 1999 and 2018 — the “massive retail bubble and hype cycle” like 1999, with inversions like 1999 and 2018.

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He crunched data on forward S&P 500 returns depending on the starting point of the 2-year/4-year spread in Eurodollars
ED00.
Right now it is on the worst part of that chart as the spread is 0.05.

Forward S&P 500 returns based on spread between 2- and 4-year Eurodollar futures

+3 months

+6 months

+1 year

All data

2.4%

4.8%

9.8%

1.9%

4.1%

9.6%

. 9

2%

4.3%

9.9%

. 8

2.2%

4.7%

10.6%

. 7

2.5%

5.2%

11.4%

. 6

2.7%

5.8%

12.1%

. 5

3%

6.2%

12.4%

. 4

3%

5.9%

11.5%

. 3

2.4%

5%

10%

. 2

1.1%

2.7%

8%

. 1

1.5%

2.5%

5.8%

-1.6%

3.3%

10.5%

Source: Spectra Markets

As of Tuesday, he was short S&P 500 futures
ES00
at 4684, and recommending taking profits at 4545, and short Ethereum
ETHUSD
at $4,210, and taking profits at $3,010.

The buzz

The Fed decision is due at 2 p.m., followed by the press conference at 2:30 p.m. with Fed Chair Jerome Powell. Markets are expecting the announcement of a faster taper of bond purchases so the central bank is in a position next year to make multiple hikes.

Economists at Nomura say the dot plot may show eight rate increases over the next three years, up from six previously, with two in 2022 versus half a hike previously. “Powell will likely use the press conference to clearly outline the steps the Committee is taking to ensure high inflation does not become ‘entrenched,’ including potentially preparing markets for earlier rate hikes in 2022, relative to our current expectation for liftoff in September, if monthly inflation does not moderate,” said economists led by Aichi Amemiya.

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There are also retail sales data due for release.

A study finds China’s Sinovac vaccine is ineffective against the omicron variant of coronavirus. GlaxoSmithKline
GSK
and Sanofi
SNY
said their vaccine candidate was effective as a booster in a preliminary trial. Europe’s drug regulator said it is recommending Johnson & Johnson’s
JNJ
vaccine as a booster, including for people who received different vaccines initially.

Eli Lilly
LLY
jumped in premarket trade after the drugmaker raised financial guidance for 2021 and 2022.

Samsara priced its initial public offering at the high end of a recently forecast range.

Errant quotes made cryptocurrency traders ‘quadrillionaires’ — on screens if not in reality.

The market

U.S. stock futures
ES00

NQ00
were slightly weaker after the second straight losing session.

The yield on the 10-year Treasury
BX:TMUBMUSD10Y
was 1.44%.

Top tickers

Here are the top tickers on MarketWatch, as of 6 a.m. Eastern.

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