Market sentiment is mixed, as investors don’t know what to do with the latest economic data and their Federal Reserve (Fed) expectations these days. Released yesterday, the US retail sales data surprised with an unexpected 0.7% rise in August versus a 0.8% decline penciled in. Stronger than expected data seemed to have fueled Fed tapering expectations rather than the bulls’ appetite. The S&P500 closed flat to negative, while Nasdaq eked out small gains, only.
Now, all eyes are on Joe Biden’s 3.5 trillion fiscal spending package which created controversies among the US policymakers, as some of them are really concerned with the high inflation, and the fact that a huge government spending would only fuel inflationary pressures, which would end up in a stagflationary setup if the economy doesn’t recover fast.
Then, there are the soaring debt levels, and the approaching US debt ceiling, which is a classic debate which will obviously end up with Americans raising their debt ceiling. But that debt ceiling discussion could push back the eventual Fed tapering to the end of the year, but not more. The Fed will likely start tapering sometime in the near future.
So, the question is always the same: higher taxes and higher yields should at some point hit the company earnings, hence their share prices, leading to an eventual downside correction in equities. Many see the size of an eventual downside correction between 5-10%.
What really prevents the correction from happening is the fear of missing out a further rally in equities, the so-called FOMO, and the fact that there is no alternative, the so-called TINA. The US 10-year yield surged above 1.30%, and pushed the US dollar higher across the board. The EURUSD tanked to 1.1750 as a result of a broad USD appreciation. But on the yields front, we are still far from an advance to 2% that many expected earlier this year, for the end of the year. And the high inflationary pressures leave investors with no place to go but the equities. Therefore, the US indices will continue claiming new highs in the coming sessions.
Due today, the European final CPI should confirm an advance to 3%. Rising European inflation, partly due to rising energy prices across Europe, should continue fueling the European Central Bank (ECB) doves, but the ECB has already played its hawkish card, announcing a slow down in PEPP purchases. Unless we see an unbearable inflation pressure, there is little chance that the ECB does anything more hawkish. Therefore, the EURUSD should continue finding direction with the Fed expectations. Though, strong European inflation should help limiting the downside potential in EURUSD, and call for a further advance toward the 1.20 in the weeks ahead.
