Time will stop today, when Jerome Powell speaks at the opening of the Jackson Hole meeting. There are many expectations regarding what Powell could say and how the market could react. Some, like analysts at Goldman Sachs think that Powell will lay out a case, as he did in his last press conference, for slowing the size of the Federal Reserve’s (Fed) rate increases. He could emphasize the risk of over-tightening the monetary policy, and causing an unnecessary slowdown in the US economy.
That’s possible, as the minutes from the latest FOMC meeting revealed that some Fed members are increasingly concerned with the risk of tightening too fast, and by too much.
But for now, the US jobs data remains relatively resilient to rate hikes and the latest growth data revealed, yesterday, a slower-than-expected contraction in the US GDP in the second quarter.
Even though, big companies announce decent layoffs as a result of tightening economic conditions, somehow, we don’t see that in the data, and their profit margins keep rising as they are passing increasing costs on to their customers.
Therefore, there is not much reason for Powell to complain about the weak economic data, however, the risk of ‘too much tightening’ is now a concern that the Fed voices, and that could be a dovish argument that could give a further relief to the US stock markets, and keep the S&P500 on track for another leg higher. In this case, the bulls’ next target will be to clear the 200-DMA offers, which stand at 4310.
But all that sounds a bit too dovish to me. In fact, it’s in Jerome Powell’s interest to stay down to earth, and focused on inflation, as triggering a market rally would have the opposite effect of boosting inflation, and this is not something the Fed wants, when inflation hangs around the eye-watering 8.5% level.
Yes, the latest data showed easing in consumer price pressures thanks to a slowdown in energy and commodity prices. But the Fed knows that energy prices are too volatile to rely on, and they are right. We see oil prices rebound again since the July dip. The barrel of US crude tested the 200-DMA yesterday, to the upside, on the back of
- OPEC’s threat to decrease oil demand
- News that Iran shipped hundreds of drones capable of being used in its war against Ukraine despite US warnings – which could complicate a nuclear deal between the US and Iran, and keep the Iranian barrels out of reach, and,
- Another 10% rise in European gas prices.
In commodities, copper futures trade 10% higher from the July dip. Meaning that the Fed’s battle against inflation is not necessarily over from the optic of energy prices.
Happily, there are some encouraging signs that inflation could still be abating in the coming months in the US. One of them is the easing supply chain problems, and the decline in shipping costs. The spot rate for the benchmark route from Asia to the US fell below $5000 per 40-foot container, for the first time since December 2020. That’s encouraging.
The second is, the US CPI tends to track the Chinese PPI and the downturn in the Chinese PPI is a good indication that we could see the same in the US CPI.
If this is the case, if we see inflation headed persistently to the downside, we could expect the Fed to slow the pace of its interest rate hikes.
Should that get the stock investors excited and jump back on the back of a bull? I am not sure, because, even if the Fed slows the pace of interest rate hikes, the winding of the balance sheet will be on full speed from September, when the Fed will start unwinding its balance sheet by $95 billion a month. And there is a lot to be unwound.
If we compare the Fed’s balance sheet to the S&P500, there is a very clear correlation between the size of the balance sheet and the level of the S&P500. The bigger the balance sheet, the higher the S&P500. Therefore, it’s more likely than not that the S&P500 keeps falling as the Fed’s balance sheet shrinks in the coming quarters.
A single word, or a tiny sentence could send the market rallying or tumbling, but it’s probably too early to call the end of the bear market before we see the impact of the QT on equity prices.
Yesterday, sentiment in major US indices was rather bullish on hope that the massive stimulus in China could boost activity and demand. The US 10-year yield eased, and the dollar retreated. The EURUSD failed to hold ground above parity, as the European Central Bank (ECB) meeting minutes didn’t do much to revive the hawks yesterday. The ECB is now committed to hike the rates and to fight the euro weakness, and inflation, but with the deepening energy crisis and the slowing economies, the European policymakers may not go as fast as their American colleagues. As a consequence, there is a stronger case for cheaper euro against the US dollar, than the contrary in the medium run.
Elsewhere, gold tested the 50-DMA on the back of softer yields and the softer dollar, but couldn’t clear resistance at this level. A dovish price action on Powell’s Jackson Hole speech could help gold bulls’ win over the bears. Likewise, a hawkish market pricing should keep the price of an ounce below the 50-DMA, and trend lower along with it.
