Dear reader, it seems we find ourselves in a bit of an economic conundrum this week. The global stock market, in its unending quest for equilibrium, has taken a tumble. Perhaps it’s the Wall Street rally that lost its steam, or maybe the unanticipated profit warning from Sartorius AG, that sent ripples through European chemical and construction firms. Whatever the cause, it has us scrutinizing the numbers a bit more closely.
Banks, it seems, are standing on slightly steadier ground, displaying a show of resilience that is a breath of fresh air amidst the foggy economic climate. However, the stability appears to be more an exception than the rule, as Asian markets, particularly the Chinese tech companies, struggle under the weight of dashed stimulus hopes.
Indeed, the Wall Street rally, having reversed a year’s worth of Fed-engineered downturns, finds itself in a precarious position. Despite the allure of an upturn, there’s an underlying current of concern. The market’s state of being overbought lingers in the minds of traders, presenting a stark counterpoint to the S&P 500’s consecutive five-week gains. This gain might be attributed to the $4.2 trillion options expiry that added pressure to the market at the end of last week.
In a move that broke the mold, the Fed chose to hold interest rates steady during their most recent meeting. However, they delivered a warning about potential tightening on the horizon. Notably, a three-month pause in rate hikes following a similar run has previously led to a boost in stock prices. Yet, in these uncertain times, predictions hold less weight than they used to.
US stock and bond markets took a breather this Monday, with future contracts on the S&P 500 and Nasdaq 100 remaining mostly unchanged. Looking forward, eyes will be on Fed Chair Jerome Powell as he delivers his semi-annual report to Congress on Wednesday, amongst other key speakers from St. Louis, New York, and Chicago.
The S&P 500’s reaction to the FOMC day was notably lukewarm, the first such meeting where policymakers chose to hold rates steady. However, this move did not come without a caveat – forecasts for higher borrowing costs of 5.6% in 2023, suggesting two more quarter-point rate hikes, or one half-point increase before year-end. This came in contrast to the market’s dovish lens, which anticipates a lower path of interest rates compared to the Fed’s dot plot.
Chinese tech stocks felt the brunt of the market’s downward momentum, with big players like Alibaba Group Holding Ltd, JD.com Inc., and Baidu Inc. each tumbling more than 3%, pulling the Hang Seng Tech index down by 2.9%. Reports following China’s State Council meeting on Friday lacked detail about potential stimulus, amplifying concerns about a slowing economy and leading to a pullback on Chinese equities.
As we glance at the week ahead, it’s clear that there are numerous vital events on the horizon. From Jerome Powell’s semi-annual congressional testimony to multiple Fed bank presidents speaking and rate decisions from numerous countries, we are poised to witness consequential moves in the market. It’s not just about the big players either; figures like Eurozone consumer confidence and Japan’s CPI also hold their weight.
In last week’s news, the Wall Street rally managed to wipe out a year of Fed-induced losses, freeing key metrics from the shadow of 500 basis points of rate increases. A new focus has emerged, with investors concentrating on corporate balance sheets and potential capital outlays as the business world gears up for the artificial intelligence boom. Non-macro themes are having a growing influence on stocks, signaling a potential shift in the market’s dynamics.
The Fed, while still a significant player, may find its role somewhat diminished in the coming months. As the prospect of a pause period looms, other global and fundamental drivers could take center stage. With the Fed hinting at an end to its rate hikes, Treasury investors are poised for a less tumultuous time, expecting volatility to dwindle after a series of unsettling yield swings.
The first half of 2023 has been remarkable, luring investors back into the fray and leading to strategy reversals from some of Wall Street’s most steadfast bears. Deutsche Bank AG’s measure of aggregate equity positioning tipped the scales to overweight, returning to levels last seen before the start of the rate hike cycle.
The ripple effects of the Fed’s tightening cycle seem to be diminishing. Volatility has ebbed in the bond and equity markets, with the ICE BofA MOVE index of expected price swings in US government debt nearing its pre-tightening low. The Cboe Volatility index, which measures stocks, is approaching levels last seen in 2020.
Even the strength of the dollar, propelled by rate hikes, has withered. The Bloomberg Dollar Spot Index trades near levels observed in April 2022, marking a near 10% fall since its record high. This development contradicts the previous year’s scenario, when markets hung on every word uttered by Fed officials.
Despite the S&P 500’s rather uneventful reaction to the FOMC day, they upped the forecast for higher borrowing costs to 5.6% in 2023. This indicates an anticipation of two additional quarter-point rate hikes or one half-point increase before year-end. Compare this with an economic climate where, based on economists’ calculations, there is a 65% chance of a US recession within a year.
Notwithstanding the recession odds, the bull market persists, challenging the idea of an impending economic downturn. Even in the face of four regional bank collapses and inversions all along the US Treasury curve, the American economy has displayed remarkable resilience. Thanks to robust labor markets and generally healthy corporate balance sheets, the economy has weathered the onslaught of rate hikes.
Bank of America strategists, amongst the market’s more pessimistic voices, recently updated their outlook for US stocks. They now foresee a “later and more moderate downturn.” Global US equity inflows in the last three weeks amounted to $38 billion, a record momentum for the asset class since October.
Yet, doubts persist. There are those who view the rally as a “bear market rally” rather than an outright “bull market rally.” They suggest that the run-up in prices sits on a weak foundation, vulnerable to a repricing to higher medium term interest rates.
The dichotomy of views and the contradictions in the market present a fascinating case study of the fluid nature of economic prediction. The market rally seems to be pulling in investors, but it also raises the question – for how long can this trend sustain, particularly if the specter of a US recession continues to lurk around the corner?
This week will be a pivotal one, as we keenly watch the market’s response to a slew of key events. In this rollercoaster ride of uncertainty, the need for vigilance and keen observation has never been more pressing. Here’s to navigating the mysterious waters of economic prediction, dear reader. As always, our watchword is caution, coupled with an insatiable curiosity about what lies ahead.
