The new week started on the quieter side, with global stocks and futures drifting and the dollar relinquishing its small overnight gains by midday in London. Crude oil recovered from earlier weakness to turn positive. There was very little macro news, with the exception of Eurozone retail sales which rose 3% in February, much better than expected. This comes as Europe finally seems to have got its act together on the vaccination race. France achieved its goal of vaccinating 10 million people a week ahead of schedule, while Germany doubled its pace of inoculations. In the UK, shops, gyms and hairdressers, as well as outdoor restaurants, have all re-opened as virus cases and deaths continue to fall thanks to the prolonged lockdowns and successful Covid vaccinations. Can we now see a consumer-led recovery in the UK and across Europe? A lot will depend on re-opening of borders for holidaymakers. But judging by the recent performance of airline shares, it looks like investors are betting that normal life can return soon. In the US, meanwhile, Federal Reserve Chair Jerome Powell is also turning more optimistic. In a TV interview, Powell said that the “outlook has brightened substantially” and that growth and job creation could start coming in much more quickly.
Much of the above optimism has already been priced in with markets in the US hitting repeated all-time highs. The market will now want to see if the optimism is justified, as we head into a busier week. As well as a busier economic calendar, the US corporate reporting season will kick into a higher gear with the release of big bank earnings. We may well see some volatility after the S&P 500 hit repeated new all-time highs on falling volumes last week. The key question going into the earnings season is this: Will company CEOs mirror investors’ optimism on economic outlook, or will they provide more subdued forecasts? Until now, investors have been quite happy to be buying any dips in equity markets amid growth optimism and despite rising inflationary pressures and valuation concerns. Covid vaccinations continue at a very good pace in the US and UK, while the eurozone is lagging behind but now they seem to have got their act together.
Dollar testing support
Keep an eye on the US dollar as we start a busy week. After ending the first quarter on the front-foot, the start of Q2 has seen the dollar weaken against most other major currencies. The underlying bullish trend could resume for the buck, especially against currencies where the central bank is comparatively more dovish than the Federal Reserve, or regions where the vaccinations have been slower than in the US. The dollar index needs to break its short-term bearish trend line and take out 92.50 resistance before the bullish trend potentially resumes. Otherwise, we may see the likes of the EUR/USD extend recent recovery.
Taper talks could resurface
One source of concern that has not materialised yet but may come back to haunt investors in the near future is the potential for inflation to overshoot as a stimulus-fuelled economy recovers from the pandemic. So far, investors seem to think that the Fed will see through any short-term price pressures as there is plenty of spare capacity left in the economy. After all, stronger economic growth should boost earnings and revenues of US companies. So, “why sell?” is what some investors would be thinking.
At some point, sky-high valuations will come back to the forefront, especially when the Fed plans to slowly withdraw stimulus. This could happen for example if inflation turns out to be longer lasting rather than a temporary shock. But policy makers at the Fed don’t think that is going to the case any time soon. They have suggested there are no imminent changes to be expected in monetary policy, according to the FOMC’s last meeting minutes. They think it will likely be "some time" until substantial further progress is made towards the maximum-employment and price-stability goals.
Inflation data eyed
This means that for now, the stimulus programme of buying assets worth $120 billion per month will continue. However, with the March employment report surprising to the upside, combined with signs of rising inflationary pressures, and not to mention the faster pace of vaccinations and fiscal support, the Fed may want to ease off the gas sooner than expected as the economy potentially heats up faster. They wouldn’t want to overcook inflation and then apply the brakes harshly. So, watch out for a change of tone from Jay Powell and co. in the coming weeks, especially if we now start to see an acceleration in inflation data. Tuesday’s release of CPI is thus going to be important for the dollar and the markets in general, as too will the speeches scheduled from various FOMC members (see below).
So, I reckon that volatility will spike sooner or later as growth optimism is replaced by inflationary concerns and taper tantrums. All it takes is a few people to start selling to get the ball rolling. With all the above macro concerns and talks about corporate tax hikes to pay for the cost of stimulus, things could unravel on Wall Street soon. Keep a close eye on the major indices -- and indeed individual names with the reporting season officially underway now.
Key economic data and company earnings highlights
Big Wall Street banks are set to report earnings next week, with JPMorgan, Wells Fargo and Goldman Sachs all due on Wednesday. On a macro level, Tuesday’s inflation data from the US is undoubtedly going to be important as it could impact bond yields, the dollar and obviously gold. Oh, and there is going to be an IPO as the largest US cryptocurrency exchange, Coinbase, goes public.