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Stocks dip as Fed shakeout continues
How do you trade the Fed? Not easily, is the simple answer. US has ripped higher as the Fed signalled it won’t let inflation run riot, but bonds have been pretty steady – 10yr yields have slipped back under 1.48%. Stocks have come off their record highs since the Wednesday meeting, but yesterday the Nasdaq Composite – composed of tech and growth companies that ought to do less well in a rising rate environment – gained 0.87%. That may be because investors are retreating to a form of quality right now. NDX rose 1.3% as the mega tech names enjoyed solid gains. The broader market was weaker with small caps -1%, commodities slipped with palladium -10%, platinum -7%, oil lower and the dollar was bid up to its best day in over a year.
European indices saw a mixed start to the session on Friday but have mostly turned red as investors dial down their risk in the wake of the Fed’s slightly hawkish meeting. What the Fed’s meeting also told us was that once inflation expectations become unanchored, it’s a tough job to re-anchor them. I continue to envisage higher yields by the end of the year but the Bank of America Flow Show report today stresses that cyclicals face a ‘perfect storm’, with ‘excess positioning, China tightening, US fiscal hopes fading, and now hawkish Fed’ combining against them. Metals are a tad firmer this morning after steep losses Thursday, but copper is still ~14% off its recent peak and set for its worst week in 15 months. A combination of a tighter Fed and China’s efforts to lower prices have worked. Gold is also set for its steepest weekly loss in more than a year as a stronger dollar and Fed’s hit job on inflation works its way through some stretched speculative longs.
UK retail sales indicated the direction of the post-pandemic economy. Sales fell 1.4% between April and May as shoppers ditched stuff for experiences, dining out more and hitting the pub again. Tesco Q1 numbers this morning evidence this, with the company reporting that sales growth peaked in March at +14.6% and moderated in April/May as restrictions eased. Tesco is starting to hit some extremely tough comparisons with last year’s pandemic-driven surge in sales. Shares in the retailer declined more than 1% towards the bottom of the FTSE 100.
Dollar strength continues to dominate the FX narrative in the wake of the Fed. GBPUSD is lower again with a break of the 100-day moving average to 1.3860. The washing out of longs maybe has some way to go yet and a test of the April double bottom at 1.3660 may be on if there is further for this to correct. Fairly stretched GBP longs and shorts on the USD mean this could have further to unwind. USDJPY trades lower at 110 support after the BoJ kept monetary policy unchanged and extended its pandemic relief programme. EURUSD is also on the back foot and trying to hold onto the 61.8% retracement of the Mar-May rally around 1.1920. AUDUSD is through the April low and testing the 200-day SMA at 0.7550. Very light data day but EU finance ministers are meeting for a second day in Brussels.
Shares in EasyJet, Ryanair and Wizz Air all rose after an upgrade for budget airlines from HSBC, which says ‘the process of reopening borders and enabling travel is assuming momentum within the EU, and the UK may follow’. EasyJet and Ryanair were both upgraded to buy from hold, whilst Wizz was given a hold rating having previously held a reduce tag. HSBC adds that whilst UK policy is ‘not easily predicted’ (you don’t say), it expects UK travel restrictions to ease.
Fed to let yields, inflation run; Bank of England to follow
Fresh records for Wall Street, a weaker US dollar, yields higher, volatility crushed: these were some of the outcomes from a dovish Federal Reserve yesterday as the US central bank resolutely stuck to its guns to let the economy run as hot as it needs to achieve full employment. European stocks moved higher in early trade Thursday but worries about vaccinations and Covid cases weigh. The FTSE 100 still cannot yet sustain a break north of 6,800 and is the laggard, declining a quarter of one percent this morning.
Longer dated paper moved a lot as Powell said the Fed would look past inflation overshooting; US 10-year Treasury yields have shot about 10 bps higher today to above 1.72%, whilst 30s are at their highest in almost two years close to 2.5%. Spreads are at their highest in over 5 years. Stock markets liked it – the Dow Jones industrial average climbed 0.6% to close above 33,000 for the first time. The S&P 500 closed within 25pts of 4,000. The Vix fell under 20.
Tracking the move in US Treasuries, gilt yields rose this morning as markets look to the Bank of England meeting to deliver the next dose of central bank action. It will leave interest rates on hold at 0.1% and the size of the asset purchase programme at £895bn. The success of the vaccine programme – albeit now running into some hurdles – has allowed the Bank to take a more optimistic view of the UK economy beyond Q1 2021. At its February meeting the Old Lady said the UK economy will recover quickly to pre-pandemic levels of output over the course of 2021. It expects spare capacity in the economy to be eliminated this year as the recovery picks up. All this really puts the negative rate conundrum on hold – the next move should be up, if not this year certainly next. Nevertheless, Andrew Bailey stressed earlier this week that the BoE is not concerned by rising yields or temporary inflation blips. So today it will be more about what the BoE doesn’t say. Remaining silent on the rise in bond yields could be the cue for sterling.
What did we learn from the Fed and Jay Powell? Chiefly, the Fed is staying its hand and letting the economy run hot. In a nutshell the Fed said inflation will overshoot but not for long; yields are moving up as part of the cycle as growth improves; and it won’t stop until full employment is achieved along with inflation above 2%. The Fed’s dovishness on monetary policy was contrasted by sharp upgrades to growth and inflation forecasts this year – but the Fed is in a new outcome-based regime focused on absolute employment levels, not on the Philip’s Curve. It also doesn’t really think the sharp bounce back this year is sustainable, meaning now is not the time to remove the punchbowl.
Transient: Things like supply bottlenecks and base effects will only lead to a “transient” impact on inflation, according to the Fed. The Fed plans to maintain 0-0.25% until labour market conditions achieve maximum employment and inflation is on course to remain above 2% for a sustained period. A ‘transitory’ rise in inflation above 2% as is seen happening this year does not meet criteria to raise rates. This is where things get dicey vis-a-vis yields since inflation could get a bit big this spring which would pressure (the Fed is immune so far) for hikes sooner. I think also the Fed should be looking around a bit more about where there is clear inflationary pressures and have been for some time, like in asset prices.
Stick: It seems abundantly clear that Powell and the Fed see no need and feel no pressure to carry out any kind of yield curve control or Twist-like operation to keep a lid on long-end rates. This is a steepener move and the market reaction was plain as we saw longer-end yields rise just as the yield on shorter-dated maturity paper declined at first. The 5s30s spread widened around 9bps to 1.66%, whilst 2s10s widened 7bps to 1.5%.
Patient: Is it time to start talking about talking about tapering? “Not yet” came the reply. Which matches expectations – any talk of tapering will not be allowed until June at the soonest when the Fed will have a lot more real data to work with post-vaccinations. That will be things get harder for the Fed as inflation starts to hit.
Outcome-based: Focus on ‘actual’ progress rather than ‘forecast’ progress. This tallies with what know already about the Fed taking a more outcome-based approach to its policy rather than relying on Philip’s Curve based forecasts. The Fed’s rear-view policymaking will let inflation loose. It also means the dots are kind of useless, but nonetheless the lack of movement on dots kept shorter dated yields on a leash, pushing real rates down. The question about what actually constitutes a material overshoot on inflation and for how long it needs to be sustained will be dealt with another day, with Powell admitting the Fed will have to quantify this at some stage.
SLR: Powell kept his cards close to his chest and only said something will be announced on SLR in the coming days. This may involve some kind of soft landing for the exemption to lessen any potential volatility.
Long end yields moved higher with curve steepeners doing well. I expect bond yields and inflation expectations to continue to rise over the next quarter – the Fed remains behind the market but this time, crucially, it doesn’t mind. Whilst Powell said the Fed would be concerned by a persistent tightening in financial conditions that obstruct its goal, the difference this time is that stock market stability is not what the Fed is about these days. Post 2008, the Fed fretted about market fragility since that is what caused the recession. Now it’s comfortable with higher yields and won’t be concerned if the stock market is lower from time to time.
With the long end of the curve anchored by the Fed’s dovishness, and longer-end yields and inflation expectations moving up, this creates better conditions for gold to mount a fresh move higher, but it first needs to clear out the big $1,760 resistance. MACD bullish crossover on the daily chart below is encouraging for bulls.
Week Ahead: Fed meets, US GDP & Big Tech earnings
In the week ahead, the Federal Reserve holds its first meeting of the new year, with a range of new appointments in place, but a major policy change seems unlikely. Latest US GDP figures are released too. Forecasts are showing a mixed but optimistic outlook for Q4 2020’s numbers. Finally, earnings season continues with big tech firms leading the large caps in the latest earnings calls.
FOMC meeting & press conference
The first Federal Reserve meeting of 2021 goes ahead next week, off the back of newly inaugurated Joe Biden’s plans for additional stimulus and Treasury pick Janet Yellen’s calls to ‘act big’ on fiscal policy. $1.9 trillion is the ballpark figure for additional economic stimulus as the US seeks to shore up its economy against the continued Covid-19 onslaught.
Four new regional Fed presidents are being rotated into the key voting spots this January – a rotation that could indicate a more dovish Fed for 2021. Out go Mester (hawk), Kashkari (dove), Kaplan (neutral) and Harker (neutral). In come Evans (dovish), Daly (neutral), Bostic (dove), and Barkin (neutral).
New members provide a little interest, but the Fed is not about to change course, with Jay Powell making it clear that now is not the time to talk about tapering bond purchases, although some policymakers have suggested this may be warranted later in 2021.
According to December 2020’s Fed meeting minutes, policymakers see rates staying in the 0%-0.25% currently targeted range until 2022, with a long-range estimate of 2.5%. No one foresees a rate hike this year. The status quo is very much in favour. According to Atlanta Fed President Bostic, a lot would have to happen for that to occur.
There is a possibility of some increases in 2023, and maybe even as early as the second half of 2022. Three key points will be looked at: the health of small businesses, the effect of Fed lending programmes, many of which were closed by the end of 2020, and temporary vs permanent job losses. Overriding all of those though will be the continued response to the Covid-19 pandemic.
Right now, it appears that the Fed will essentially be staying the course, committing to policy established across the course of 2020.
Latest US GDP figures released
Like pretty much every advanced economy worldwide, the US was rocked by repeated blows from the Covid-19 pandemic. Thursday sees the advanced reading of Q4 GDP stats and the picture looks muddled to say the least. GDP diagnoses really depend on who you ask.
The Atlanta Fed’s GDPNow model forecasts 7.4% annualised growth in Q4 as of its January 15th release, although this has been revised down from 8.7% forecast on January 8th., The New York Fed’s Nowcast model indicates 2.5% expansion.
GDP growth will all depend on which economic sectors can back on their feet fastest. The US Commerce Department stated recently that consumer spending, the US main economic engine, had been revised upward slightly, alongside fixed business investments. However, these were tempered by a drop in exports. Services, where 61% of consumer spending goes, were down 17% year-on-year in third quarter of 2020 – can they recover? Time will tell.
Earnings Season – Apple, Microsoft and Facebook lead the large caps
Earnings season continues on Wall Street and this week the focus shifts to tech giants. Big tech seems like it’s getting bigger and bigger with lockdowns playing into the sector’s hands. Will earnings reports confirm that?
Apple could be onto its first-ever $100bn quarter as the consensus EPS climbs 12% year-on-year to $1.40. Holiday shopping season falls squarely into Apple’s first-quarter reporting, and with a multitude of iPhone 12 models hitting markets – enough for 30% rise in production numbers this quarter – the indicators a bumper earnings call coming from the California tech giants are pretty strong.
Microsoft has been a winner. If you’re working from home, you’ve probably had to grapple with Microsoft Teams, now the de facto business communications software of choice for businesses around the globe.
Cloud computing solutions are helping Microsoft push record quarterly revenues. With the increased uptake of products like Azure, GitHub, SQL Server, and Windows Server, commercial cloud services have generated 31% more revenue y-o-y in the recent quarter, hitting $15.2bn. Combined with its other productivity-led software, i.e. Office, Teams, etc., Microsoft Q1 2021 revenues are on course to reach $40.2bn.
Facebook’s reputation has taken a bit of a hit in recent months. The spread of fake news and hate speech on the platform is one of the major complaints levelled at the company.
Despite this, Facebook reported 12% growth in active daily users in the last quarter, up to 1.82bn, while monthly active users grew at the same rate, reaching 2.74bn – just over a quarter of the global population. Ad revenues are up 22% y–o–y too, even in the face of a boycott from 1,000 prominent advertisers.
See below for a full breakdown of the large caps reporting earnings this week.
Major Economic Data
|Mon Jan 25|
|Tue Jan 26||7.00am||GBP||Unemployment Claims|
|3.00pm||USD||CB Consumer Confidence|
|Wed Jan 27||12.30am||AUD||CPI q/q|
|3.30pm||USD||US Crude Oil Inventories|
|7.00pm||USD||Federal Funds Rate|
|7.30pm||USD||FOMC Press Conference|
|Thu Jan 28||1.30pm||USD||Advanced GDP q/q|
|1.30pm||USD||Advanced GDP Price Index q/q|
|3.00pm||USD||CB Leading Index m/m|
|3.30pm||USD||US Natural Gas Inventories|
|Fri Jan 29||8.00pm||CHF||KOF Economic Barometer|
|3.00pm||USD||Pending Home Sales m/m|
Key Earnings Data
|Mon 25 Jan||NIDEC|
|Brown & Brown|
|Equity Lifestyle Properties|
|Tue 26 Jan||Microsoft|
|Johnson & Johnson|
|Canadian National Railway Co.|
|Maxim Integrated Products|
|LG Household & Health Care|
|Nitto Denko Corp.|
|Wed 27 Jan||Apple|
|Shin-Etsu Chemical Co.|
|Automatic Data Processing Inc.|
|Norfolk Southern Corp.|
|Edward Lifesciences Corp.|
|TE Connectivity Ltd|
|Las Vegas Sands Corp.|
|Ameriprise Financial Inc.|
|Hormel Foods Corp.|
|Nomura Research Institute|
|Raymond James Financial|
|Packaging Corp. of America|
|Thu 28 Jan||Samsung|
|Air Products & Chemicals|
|Walgreens Boots Alliance|
|Stanley Black & Decker|
|McCormick & Co.|
|Arthur J. Gallagher & Co.|
|Fri 29 Jan||Eli Lilly|
|Simon Property Group|
|Church & Dwight Co.|
|Svenska Cellulosa AB|
|Booz Allen Hamilton|
Brexit talks go to extra-time, AstraZeneca drops on takeover
- Sterling rises as Brexit talks are extended again
- European markets opened higher and US futures up
- US stimulus in focus, Fed meeting later this week
Brexit talks are going into extra-time; neither side want it to go to penalties. Both the UK and EU say they will continue talking and want to go the ‘extra mile’. The market read this as progress towards a deal, although the two sides remain far apart on the last big issues. Sterling gapped higher at the Sunday night open, with some shorts maybe covering their positions on the extension. GBPUSD advanced to 1.34, bouncing on hopes of a deal, while the 200-day simple moving average offered the near term support. The pound also strengthened versus the euro as EURGBP dipped from the 0.92 area traded on Friday back towards 0.90. Those gaps may offer some decent intraday support but unless hopes rise in the next day or two would be liable for a fill. Sterling still trades with headline risk, but the truth is the ranges remain very tight and the failure to break out in either direction reflects the fact that the outcome remains very binary and both deal and no-deal are still very much in play. It’s probably a toss of the coin now whether we get a deal or not.
British banks with high exposure to the UK economy and property market remain high beta Brexit stocks – Lloyds and Natwest both rose 5% in early trade having taken a bit of a thumping at the end of last week. Likewise, housebuilders popped 5% higher on Brexit deal hopes. These stocks are a leveraged bet on the UK economy, which in the near-term at least is going to be at the mercy of a Brexit trade deal and the vaccination programme. Markets have also pushed back expectations for interest rate cuts by the Bank of England, which meets later this week.
AstraZeneca shares dropped 6% – seemingly on fears it’s paying too much for the US biotech company Alexion. Whilst the 45% premium may seem high, it’s probably not that significant when you consider the sector and the cash flow generation and revenue growth that it will bring. Debt taken on to buy the company will be repaid quickly. Richly-valued AZN shares needed to do some work too. It’s a big turnaround from the dark days of six years ago when Pfizer tried to land AstraZeneca.
Elsewhere it’s a familiar story of hope around fiscal stimulus in the US and vaccines being rolled out, with the Pfizer/BioNTech jab being rolled stateside today as part of a programme that will see 100m people inoculated by the end of March. Vaccines will continue to support risk sentiment and provide succour to the stock market as it enables investors to look past the current situation to a more normal 2021. For the time being Main Street needs help and as far as stimulus goes, getting a deal through Congress is proving as difficult as Brexit. The $908bn bipartisan package is being put forward today, but it’s uncertain whether it will pass.
The Federal Reserve meets later this week, with attention on its emergency $120bn monthly bond buying programme. It’s expected that the Fed will anchor expectations around the longevity of the asset purchases to make it clear it’s in this for the long haul. With 10-year Treasury yields rising in recent weeks, and coming close to 1% again, it may also choose to switch its focus to longer dated debt in order to better anchor interest rate expectations for a longer duration.