Although US index futures point to a firmer open on Wall Street, it remains to be seen whether the bulls will be able to hold their ground in the face of rising concerns over stagflation. Crude prices have broken out again, a day after the OPEC+ agreed to raise oil output by 400K barrels per day instead of 800K bpd, with a pause in December. The impact of the OPEC’s decision has disappointed those calling for a bigger hike, and oil prices have risen as a result. This is only adding to inflationary pressures, especially for some emerging market economies who are also large oil importers like India. Rising oil prices are also keeping bond yields underpinned, and overvalued and technology shares undermined, as investors expect to see tighter monetary conditions from the Fed and other central banks in the months ahead.
Are we in stagflation already?
To be clear, I don’t think we are there yet, but we could be heading towards a period – and some sort – of stagflation, if the current macro trends don’t change. It all depends on one’s view of how high inflation needs to be in relation to how fast the economy is slowing down to call it stagflation. While there is little doubt about high inflation persisting longer than expected, what is unclear is whether growth will weaken significantly, or unemployment rises noticeably to call this stagflation. GDP is still expanding, and US unemployment rate is just over 5%, which is not high enough – thankfully – to call it stagflation. A surprise economic contraction in one of the next few quarters could certainty remove any doubts as to whether we are in a stagflation period. This will depend largely on the supply-side bottlenecks, although demand could also weaken now that government support is slowly being replaced by higher taxes to pay for the record fiscal spending made during lockdowns to stimulate the economy.
What factors are driving stagflation concerns?
I think rallying crude oil for a large part – especially for emerging market economies who are also net oil importers. India and China to name a couple. Even in the more advanced economies, rising crude oil prices have raised fuel prices, directly impacting consumers’ disposable incomes. The other factors are driven by other energy prices – most notably gas, but also surging electricity prices – as well as supply-chain bottlenecks – the latter raising both inflation and hurting economic growth.
What does it all mean for the markets?
If stagflation lingers, central banks will be unable to do much about it because (1) monetary policy is already globally extraordinary loose and (2) and further loosening is going to overcook inflation even more, which is not something they would pursue in periods where prices are already on the rise.
Against this backdrop, the current bearish sentiment towards equities could remain in place for a lengthier period of time than previous cases of when we had market turmoil. Meanwhile, bond yields should rise amid haven flows and expectations of tighter monetary policy. This will offset some of the havens flows into gold as we have already witnessed with directionless prices. Currency markets will be impacted relative to one another. For example, in Japan, where inflation has been non-existent, the Bank of Japan will be less inclined to fight off inflationary pressures by tightening its policy. In contrast, the US and UK, for example, would be more inclined to do so. Everything else being the same, this should put upward pressure on the likes of the USD/JPY and GBP/JPY – for as long as sentiment towards risk assets do not turn significantly negative to trigger haven flows into the relative safety of the Japanese yen and bonds.
Nasdaq could drop another 500 points?
With lots of support levels broken, the Nasdaq is in danger of staging an even deeper pullback thanks to the above macro concerns. On Monday, the index formed a bearish engulfing candle, potentially pointing to further weakness. Short-term resistance around 14550, Friday’s low, was being tested at the time of writing. Once support, we may see a drop from around this area. The next big downside target is around the 200-day average circa 14050. That’s around 500 points below market, but we could see this level being tested given the bearish sentiment towards the technology sector.
Source: ThinkMarkets and TradingView.com
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