The week kicked off with major US indices renewing record on the back of an increased interest in technology stocks on broad conviction that the low interest rates and the cheap liquidity is here to stay despite improved recovery prospects, encouraging jobs data and overshooting inflation. Investors trust Jay Powell more than they trust their own father in that he won’t remove the liquidity rug from under their feet.
Nasdaq advanced to a fresh all-time high with investors turning a blind eye on the reflation recommendations, and they weren’t wrong. In the actual low interest rate environment, the rising inflation only pressures the real interest rates deeper in the negative territory and that’s a boon for growth stocks.
European futures hint at a positive open on Tuesday and FTSE should benefit from firm oil prices.
The Federal Reserve (Fed) begins its two-day meeting amid fresh records on equity markets, quite strong jobs figures and inflation at 5%. But there should be no change in FOMC’s ultra-supportive monetary policy stance. The only hawkish risk is the taper talk, or more precisely, a talk on when the Fed would start the taper talk. But the chances are, we won’t hear anything crispier than the Fed officials not opening that discussion any time before September, as cutting bond purchases is just an appetizer in a full course menu, and no one’s willing to move on to the main course, rate normalization, just yet.
But it’s worth noting that not everybody is equally comfortably with the fast rising inflation. New York Fed for example revised its 1-year inflation expectation to 4% in May from 3.1% a month earlier.
Still, the US 10-year yield remains comfortably near the 1.50%, and the gap between the US inflation and the 10-year yield is at the highest since 1980. To me, Fed’s muted strategy versus the rising inflation is like keeping a lion in a cage; measures to manage the risk of seeing a delay in softening inflation are being overstepped, which could result in a quick adjustment of the US yields in case of a proble,, which, in return, would shatter the stock markets. Therefore, despite the US big caps flirting with record highs, the red flags are there, and one of them is the persistent rise in oil prices.
The barrel of US crude pushes higher above the $70 mark on the back of a sweet blend of improved economic activity and travel, prospects of stronger global demand, a strict OPEC supply and a fast-declining global glut as a result of higher demand and relatively softer supply. The risk that Iran could shortly see its sanctions lifted and add some 4-6 million barrels a day into the mix isn’t be a major concern for oil bulls, as the additional oil supply could easily be absorbed by the rising demand. But there is one thing that could dent the oil rally: inlation. The rapid rise in oil and commodity prices fans the inflationary pressures and if we don’t see stabilizing in raw material prices shortly, the Fed’s transitory-inflation theory would fall in ruins and force the Fed to tighten financial conditions earlier than thought. If that is the case, the recovery prospects would ease and weigh on oil prices, in return. In conclusion, oil’s upside potential will likely remain capped by its own success. And I believe we won’t see the barrel trading above $75/78 area without inviting the bears to the table.
Gold, on the other hand, is set for extending losses toward the 200-day moving average, $1840 per oz. If the combination of subdued yields and high inflation couldn’t bring gold bulls to the party, then there’s more interest in riskier and better-rewarding assets.
And interestingly, we see an interesting negative correlation between gold and Bitcoin, again. Gold’s recent surge above $1900 per oz had coincided with Bitcoin sell-off, and symmetrically Bitcoin’s recovery seems to pressure gold prices lower. It doesn’t mean Bitcoin is alternative to gold, on the contrary. Bitcoin is correlated with risk assets, and improved risk appetite, which sends the safe-haven gold lower, has a supportive effect on Bitcoin. Of course, Bitcoin’s recent surge has been triggered by an Elon Musk tweet, which said Tesla would resume transactions in Bitcoin, if Bitcoin mining becomes sufficiently green. So the negative correlation could only be a coincidence.
