Currency and Stock Markets. Daily Insights

stoch

Active Member
Preview of the Fed meeting: 75 bp move is fully priced and “sell the facts” scenario is likely in the Dollar



The Fed will likely yield to the hawkish market expectations and hike interest rate by 75 bp today. Nevertheless, even with such an aggressive move, it cannot be ruled out that the dollar will go into decline following the meeting. Why? Since last Friday, when the May CPI was released, the dollar index has strengthened by a significant 2.4%, setting a new local extreme (105+). Such a move has likely already priced in a 75bp increase in the federal funds rate, so without additional surprises related to the pace of the timeframe of QT or a sharp revision in Dot Plot, a FOMC meeting broadly in line with expectations could become a profit taking signal. In other words, the classic “sell on the facts” scenario can be executed in the dollar market.

Asset prices on the market, as well as expectations for the June meeting of the Fed, have changed significantly over the past week. Futures on the Fed rate have completely priced out an outcome where the Fed hikes rate by 50bp. This was supported by inflation data for May and inflation expectations from U. Michigan: headline inflation rose from 8.3% to 8.6% and 5-year inflation expectations of households jumped from 3% to 3.3%. Media reports, that the Fed policymakers were seriously discussing the possibility of raising rate by 75 bp, did their job as the market regarded them as an attempt by the Fed to prepare the markets for such a move during the blackout period - the week leading up to the meeting, when Fed officials are not allowed to make policy statements. In terms of market dynamics, key U.S. stock market indices are down nearly 9% and there is a chance the Fed may try to choose a softer path to limit correction or even boost stock market gains so that the welfare effect smooth out the negative impact of inflation on consumption propensity.

The upcoming Fed meeting is especially important because it will feature an updated Dot Plot - a chart showing the distribution of FOMC participants' assessments of where the interest rate should be in the short, medium and long term. The latest Dot Plot was published in March and looked like this:






It's been three months since then and inflation hasn't gone down, so markets now expect the Fed's rate to be in the 3.5-3.75% range by the end of the year. The Fed will most likely move the median forecast to this range, but officials’ expectations regarding the rate next year and 2024 will become more important for the market. If at least a few officials are in favor of raising the rate to 4% and above, then most likely we will see a new rally in DXY to 105.50 or even higher, as expectations for tightening from other major central banks are much more modest.

US retail sales data for May came with a big downside surprise today pointing to increased risks of stagflation for the US economy:






It is interesting that the negative reaction of the dollar to the report did not last long, as a weak consumption report could increase the chances that the Fed will fight hard against the main negative factor - high inflation and aggressively raise the rate today:





Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

stoch

Active Member
The Fed is ready to pay a high price to suppress inflation



The Fed raised key interest rate by 75 basis points and signaled that a similar move could be expected in July. The announced pace of tightening means that the federal funds rate is likely to be above 3% by the end of the year, therefore the dollar will likely offer one of the best real yield prospects among G10 peers in the second half of the year. However, a decisive fight against inflation will have its costs, namely, mounting risks of a "hard landing" of the US economy, in which case the Fed may need to ease policy as quickly as it tightened it.

After the first in 22 years rate hike by 50 bp in May, the Fed accelerated the pace of tightening and moved to a 75bp hike, confirming the trend of major central banks to step up the pace of policy normalization. Markets were preparing for such an outcome in advance, in particular, these expectations were based on US inflation data for May, which showed that inflation peak had not been passed, as well as household inflation expectations from U. of Michigan, which jumped in the previous month, threatening to deanchor from the Fed target. This, in turn, was fraught with a loss of credibility in the Fed, which is a major cost of conducting monetary policy, so yesterday the Fed showed determination and hinted that even 75 bp rate hike is not the limit.

New Fed forecasts indicate that the pace of policy tightening will remain high for at least the next few months or even until the end of the year. The median interest rate forecast for the end of this year has changed from 1.9% to 3.4%, from 2.8% to 3.8% for the end of 2023, from 2.8% to 3.4% for the end of 2024 and from 2.4% to 2.5% for the long term. Even traditional FOMC doves expect federal funds rate to climb above 3% by the end of the year:





In the accompanying statement, the Fed excluded the wording that the Central Bank “expects inflation to gradually decline to the target level”, instead using “committed to fighting inflation and is “highly attentive” to risks in this area.

Such an aggressive stance in monetary policy was not without an increase in expected costs, which the Central Bank acknowledged in its GDP and inflation forecasts. According to the fresh economic staff projections, the Fed lowered its expected GDP growth rate in Q4 2022 from 2.8% to 1.7% and from 2.2% to 1.7% for Q4 2023:





The risks to the Fed projections on the path of the interest rate are clearly on the upside. The natural movement of inflation towards the target level at the pace desired by the Fed implies that supply should adjust to strong demand. However, restrictions due to covid in Asia and a shortage of labor in the US suggest that this will not happen quickly. Therefore, inflation can remain sustainably at elevated levels, forcing the Fed to destroy consumer demand with monetary tightening in order to bring inflation back under control.


Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

stoch

Active Member
Central banks of major economies fail to keep up with the Fed tightening pace



Volatility in FX market remains stubbornly high, a series of upside surprises in inflation data for May apparently caused "tectonic shifts" in policy stances of many central banks, which rushed to drop hints about the need to speed up tightening process. And in overall, we can say that their words do not diverge from deeds. The dollar index plunged yesterday towards support at 104 level after the Swiss Central Bank surprised with a 50bp rate hike with additional bearish greenback pressure coming from expectations that the Bank of Japan and Bank of England will follow suit:






However, BoE’s and BoJ decisions fell short of hawkish hopes as the Japanese Central Bank decided to leave the rate and QE settings unchanged while the Bank of England unanimously raised the rate by modest 25 bp (no votes for 50 bp which is quite dovish in the current setup). The Cable is losing moderately against the dollar on Friday while stubbornly dovish BoJ was apparently a big surprise for the markets, which expected a rate hike. Lack of the hawkish move sent USDJPY up by almost 2% and a retest of the 135 level seems to be around the corner.

Given recent comments of the BoJ that it’s ready to dampen any irrational move in the exchange rate, an upside spike in USDJPY above 135 will likely to be a red line for the Bank of Japan. This has some serious implications as a powerful attempt to reestablish normal USDJPY exchange rate may require the BoJ to sell other reserves from the balance sheet, which could be US Treasuries. Upward pressure in long-term yields, such as a rally in 10-year Treasury rates to 3.4% or more, will likely allow the dollar to focus on a retest of recent highs.

The recent significant gains of the dollar led to increased number of currency interventions from major central banks. For example, the Central Banks of Switzerland and the Czech Republic were selling reserves in order to contain the fall of their national currencies. The Bank of Japan, apparently soon, will also apply unconventional measures. The risk of intervention by a major player in the foreign exchange market and relatively high yields to maturity in bond markets are likely to maintain elevated volatility levels in FX space.

The dollar, taking into account all these factors, is likely to continue to strengthen. The US economy, unlike many others, went into the inflation shock with economic output above potential which means risks of stagflation in the economy due to monetary tightening in the US are lower than in its major counterparts, which means that real yield outlook in the US is set to remain the most attractive. In addition, at the time of powerful risk asset sell-offs, liquidity in the market tends to decrease which creates additional demand for dollar as for the most liquid asset.



Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 
FED goes all-in to fight inflation and markets are yet to grasp this shift in the policy stance


The tectonic shift in the Federal Reserve’s policy, according to which the regulator no longer expects that inflation will naturally find its way to the target level and goes all in to suppress it, is still being digested by financial markets. Risk demand recovers slowly, despite the fact that last week's drop largely removed overbought, European and Asian equity indexes show mixed performance today with gains barely exceeding half a percent. Powell's testimonial is due this week, which will likely be used by the Fed chair to shape correct expectations for the July meeting and he will most likely pitch discussion to explain why another 75 bp move may be needed. Consequently, bullish surprises for the dollar seem to be not over, and any pullbacks in the Dollar index are not expected to linger. EURUSD is likely to find support at 1.04-1.0450, but the risk of a breakout below the near-term support zone is not negligible:





Stock indices sluggishly rise on Monday, US markets are closed due to the national holiday. One gets the feeling that investors have not yet fully realized the large-scale changes in the policy of the Fed. Last Wednesday, the regulator hiked interest rate and did not rule out that in July it could raise the rate at the same pace, but by the beginning of this week it became clear that such a scenario became baseline, derivatives based on the Fed rate (overnight interest swap), priced in additional 70 bp tightening in July.

Over the weekend, Fed official Waller spoke openly in favor of a 75bp move especially if there are no surprises in the macroeconomic data for June, also saying that inflation needs to be reduced no matter where it comes from. Waller is a known hawk and it's clear that his mindset probably isn't dominating most FOMC members, but the signs that the Fed is putting more, if not all, effort into fighting inflation have become clear enough that it will take time for the market to fully price it.

At the same time, along with tightening of the Fed's policy, the chances are growing that the economy will fall into recession next year, which will force the Fed to move to cut rates and resume QE. According to BoFA, the probability that the US economy will fall into recession next year has risen to 40%, while high inflation will persist due to the resilience of pro-inflationary factors on the supply side. In other words, destroying consumer demand may not be enough. Bank analysts expect GDP growth to slow to near zero in the second half of next year as lagged tightening of financial conditions starts to cool demand in the economy. The rebound in 2024 will be moderate.

This week the economic calendar is not particularly remarkable, the markets may pay attention to the real estate data in the US. Indeed, the US real estate market is now gaining attention, as rapidly rising mortgage rates and declining consumer confidence indicate that this week's reports could be disappointing, especially the existing sales numbers:



The significance of this data should not be underestimated, as housing construction makes a significant contribution to GDP (about 2%), and home sales are positively correlated with retail sales data. Existing home sales are expected to rise by 5.4m from 5.61m in the previous month, the weaker figure could fuel risk aversion in the market.



Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 
EURUSD is poised to break 1.06 but further upside looks limited


After a turbulent past week, calm has finally returned to the markets. Demand for risk assets slowly recovers: European indices have been rising for the third day in a row, US futures rebounded by more than 1.5% on Tuesday. The dollar index (DXY) fell against the euro and the pound, rose against commodity currencies amid falling oil, and gained significantly against the Japanese yen on worries that BoJ can’t handle situation in the JGB market. The Fed appeared to be unconvincing last week with a 75bp rate hike as US debt market yields continue to rise. The yield on 10-year US bonds rose from 3.19% to 3.29% since last Friday:




Optimism in the markets looks like an appropriate reaction to Biden's announcement that he is considering temporarily abolishing the federal fuel tax. However, this initiative must be approved by Congress, which will not be easy because the Republicans want the situation with high gas prices to cause maximum damage to the reputation of the US president and the Democratic Party. If the tax holiday can be passed through Congress, then on the monetary policy front, we may see more confident action from the central bank. In this case, we can expect a higher investment demand for the dollar. In general, the fiscal policy factor, which has receded into the background after the post-COVID stimulus, may again begin to play a significant role in the pricing of the dollar.

The main events of the economic calendar today will be the release of statistics on existing US homes sales, as well as the speech of Fed policymakers Tom Barkin and Loretta Mester. Home sales are expected to slow down again, but investors are likely to be reluctant to see this as a signal to lower interest rates, having already been burned their fingers last month when they tried to price in "September pause" in the Fed tightening. The next important event for the dollar and for the bond market will be Powell's testimonial in the Senate on Wednesday, which, judging by the latest Fed meeting, will also be hawkish, and therefore the dollar downside will most likely be limited.

The EURUSD consolidates around 1.055 searching for a new catalyst. News that the ECB has developed a new anti-fragmentation tool for the bond market seems to have been able to reassure investors as the yields of EU peripheral bonds turned into decline. The spread between the yields of 10-year Italian and German bonds, the main indicator of credit risk in the EU debt market, fell to 199 basis points from 242 bp last week:





In the run-up to Powell testimonial, EURUSD will likely remain in the range of 1.05-1.06, however barring any ultra-hawkish hints, the dollar can be “sold on the facts” causing EURUSD to retest or even break 1.06. However, given that stagflation risks persist and are higher for energy import-dependent EU countries, a break above 1.06 could be a good opportunity to short the pair:




Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 
S&P 500 is again the red and more downside seems likely



Risk assets traded in the red on Wednesday, with the dollar rebounding from its recent short-term downtrend as debates about impending recession successfully enters the mainstream. Several large investment banks have already estimated the chances of a recession starting from the 4th quarter of 2022 at more than 50%, which, against the backdrop of the central banks’ “no-tolerance” inflation policy, becomes an even more depressing forecast. Governments and central banks have practically no tools left to smooth out the recession: one way or another, their effect is reduced to creating positive demand shocks, which is unacceptable in conditions of high inflation and negative supply shocks.

The dollar index is again approaching multi-year highs as bearish factors are at play in both two key asset classes – stocks and bonds. Slightly negative dynamics is also observed in the sovereign segment of the debt market - bonds with 10-year maturity in the US and Germany offer a slightly lower yield than yesterday.

Of the latest economic updates, we can highlight the data on inflation in the UK. Headline monthly inflation was 0.7%, better than expected, consensus again underestimated producer price inflation, annual PPI of input prices reached 22.1% (forecast 19.4%), monthly PPI - 2.1%. UK inflation figures are the highest in 40 years:



Investors have not yet received a clear explanation from the British Central Bank what it will do with high inflation, at the last meeting there was a modest increase in rate by 25 basis points, there wasn’t any clue in the policy statement that the Central Bank will throw all its efforts into fighting inflation (as stated Fed), that’s why the inflation report made a negative impression on the pound, which today is more actively losing ground against the dollar compared to the European currency. GBPUSD is testing from above 1.22, mainly bearish sentiment for the pair will remain until the price remains below the resistance zone of 1.2320 -1.2380:





The oil market is showing a long-awaited positive momentum, with prices moving towards the $100 per barrel level, as fears of a subsidence in demand due to the threat of a recession seem to be beginning to outweigh the signals of a shortage on the global supply side. Lower prices allow us to expect a weakening of general inflation in the coming months and the markets will probably gradually begin to price in this important signal, however, in order to consolidate this optimism, it is necessary to see a softening stance on the side of central banks, primarily from the Fed.

Classic recession indicators confirm that pessimism is slowly starting to dominate sentiment. The spread between 10-year and 2-year US Treasuries is approaching zero again:





All in all, equity prices seem not have bottomed out, the dollar's medium-term rally has not run out of steam, and downward risk asset pressure will likely remain abound until the market begins to expect that the US Central Bank is ready to soften rhetoric in response to market participants' fears of a recession. Technically, the S&P 500 index is near the lower bound of the trend channel, which points to higher chance of a rebound, however, unlike previous movements towards the lower bound, market participants were less active in buying the dip intraday, so the price may try to test the level of 3600 and below in an attempt to elicit more powerful bullish response before we can talk about an upward correction:



Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 
Another day of relief rally in equities keeps dollar under pressure



A batch of latest estimates of PMIs in Eurozone released yesterday triggered a wave of mild risk-off and showed how the difference in expected growth rates between the EU and other economies is becoming an increasingly important driver in the foreign exchange market and, judging by the latest data, does not bode well for the European currency. Manufacturing PMI in France fell from 54.6 to 51 points (forecast 54), in Germany - from 54.8 to 52 (forecast 54), in the Eurozone - from 54.6 to 52 points (forecast 53.9). The slack of activity in services sector was less severe as rising share of services in consumption continues to support the sector, this trend emerged after covid and has not yet fully exhausted itself. Indices of activity in the service sector and manufacturing in the UK were generally in line with forecasts, which limited sell-off in the British currency.

Downbeat vibes in equity markets on Thursday were replaced by another leg of relief rally on Friday as gains in US equities somewhat diverted attention from recession risks, S&P 500 at the close approached 3795 points, DOW breached 30600 points. Nasdaq showed the most significant gains among key indices - 1.47%. However, betting on a full-fledged rally is premature as incoming data gave only the first indications of a possible recession and investors will probably prefer to remain in a wait-and-see stance.

The pound strengthened against the dollar despite a dismal retail sales report, buoyed by an overall uptick in risk asset markets. The annual decline in retail sales in May reached 4.7% (forecast -0.5%), retail sales excluding fuel decreased by 5.7%, reflecting the decline in the purchasing power of household income due to extremely high inflation.

Heightened fears of a recession are fueling recovery of the government bond segment in the debt markets of developed countries. Thus, the yield on 10-year treasury bonds has decreased from the local peak value of 3.50% to 3.11% in the last 10 days:




Demand for long-term bonds rises when investing in a long-term bond becomes more profitable than investing in a series of short-term bonds. At the same time, time spreads between bond yields also narrowed, suggesting growing expectations that after a short period of monetary tightening, an equally rapid reduction in interest rates will follow.

Several FOMC members are already openly calling for a 75bp rate hike in July and then reduce the pace of tightening to 50 bp. In his speech yesterday, Fed Chairman Powell downplayed the threat of recession and focused on positives such as labor market gains. In addition, he said that the goal of quantitative tightening is to reduce assets on the balance sheet by $2.5-3 trillion. The Fed's current assets on the balance sheet is close to $9 trillion, with about half bought up in 2020-21:




Bullard, speaking today, also said that there were no signs of a recession and that the rate hike would slow the economy down to a natural trend. The Fed official openly spoke in favor of raising the rate to 3.5% by the end of the year.

The Fed's hawkish stance is likely to support the dollar in the short term, so a correction now looks unlikely. The dollar index has been consolidating in a narrow triangle for the last week, which usually precedes a breakout movement. Support for the index is at 103 (50-day SMA), in early June, the index rebounded from the level, confirming that bullish sentiment continues to dominate the US dollar:




Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.
High Risk Warning: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 75% and 72% of retail investor accounts lose money when trading CFDs with Tickmill UK Ltd and Tickmill Europe Ltd respectively. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
 

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