Markets pull back ahead of a busy week

 
The European market volatility continues. After Friday’s sizeable recovery, the major indices here have started the new on the backfoot, with US index futures, copper and crude oil prices also pulling back. The US dollar has steadied after falling sharply on Friday, and this has caused precious metals to also edge lower. The pound has given back a good chunk of its gains made on Friday after “football is coming home” optimism got shattered last night. On a more serious note, the mildly negative sentiment is mainly a reflection of the uncertainty the delta variant of Covid is causing, while profit taking ahead of the upcoming bank earnings and macro events this week was also adding to the selling pressure. The rising cases of the delta variant is a major cause for concern even as the UK’s full re-opening plan is likely to go ahead. But it does raise questions over how the summer holidays will be impacted and by extension the global recovery. It is more of a concern for emerging markets since vaccinations in those regions are still moving slowly. Still, with the markets relying so much on central bank support, anything that causes a delay in tapering QE purchases should be positive for stocks. So, I doubt Monday’s weakness will last very long.

 
Meanwhile investors are also easing off the gas ahead of a busy week for data and earnings, both of which were quite quiet on Monday. Some investors clearly will want to gauge whether the corporate profitability can support equity valuations at these levels before taking on more risk. Others are happy to book profit after what has been another solid quarter for equity prices, especially in the US.  
 
 
 
Last week provided us a snapshot of how vulnerable the markets can be, although on that occasion investors were happy to buy the dip on Friday after a sizeable in mid-week. Crude oil, which had also dropped on the back of OPEC infighting and concerns over rising delta variant of Covid-19, also rebounded sharply on Friday. It was risk back on as calm returned to the markets, in part because of China’s moves to bolster its economy with the People’s Bank of China cutting the reserve requirement ratio.
 
Ahead of the upcoming bank earnings, we may see the markets again find buyers later on, in what otherwise looks like a quiet session.
  
 
Central Bank support still main driver for markets
 
There are many conflicting signals for investors to deal with, but amid all the noise they still appear happy to do what they have been doing since everything bottomed out in March: buy the dips in stocks.

 
The latest, and short-lived, dip was provided by worries about tapering of bond purchases by the Fed and other central banks, and as optimism over a sharp global recovery was slowly being replaced by mild fears that growth is nearing a peak.

 
The PBOC’s move to trim the amount of cash lenders must hold in reserve has eased concerns over major central banks tapering their emergency stimulus measures in the coming months. On top of this, the ECB’s slight change of inflation target to 2% from “close but below 2%” means the central bank will tolerate an inflation overshoot and thus keep its policy loose for even longer. The FOMC’s last meeting minutes revealed officials still felt that substantial further progress on the US economic recovery "was generally seen as not having yet been met."
 
So, you get the picture, central banks are still likely to keep their respective policies loose. And although rising cases of the delta variant of Covid-19 has weighed on the recovery prospects, this only increases the likelihood of low rates and more QE for longer. Still, it is worth watching bonds as the recent drop in yields is indicative of some investors re-thinking the reflation trade.
 
How will markets react in week ahead?

We could very well see some further upside for equities after a weaker start on Monday and in light of how quickly sentiment turned positive after a sizeable drop on in mid last week. The focus will turn to the upcoming macro events and company earnings. Individual stocks, especially in the banking sector, should move sharply as investors respond to the quarterly results of Wall Street giants. Later in the week, the stock market rally may fade should yields resume lower again, after the US 10-year finally found support at 1.25% last week after several down days. This is the key risk facing investors in the week ahead, in my view. There are plenty of triggers for this, including US CPI, Chinese GDP and company earnings and guidance (see calendar below).

 
Bank earnings unlikely to repeat Q1 performance
 
The major US banks will report their quarterly earnings results in the coming week (see below). After a very positive first quarter, lenders may very well struggle to top those numbers in Q2. Indeed, Wall Street analysts on average expect EPS and revenue to decline from levels seen in the first quarter. Still, with the Covid-19 vaccinations having been ramped up and the economy recovering stronger than expected, don’t expect to see many disappointments either. In fact, it is quite possible that with lowered expectations, banks might be able to beat consensus, though probably not like Q1 style. One source of surprise in Q1 was the release of large reserves that some lenders had previously stowed away for loan losses that didn't materialize. Expect the banks to release more such funds as the impact of the pandemic was largely offset by significant intervention from the government and the Federal Reserve. The quieter market conditions in Q2 means profits from trading operations will most likely be lower than in Q1 for US banks.
 
Macro calendar and earnings highlights
 
Tuesday

 
Wednesday

 
Thursday

 
Friday