The markets have been fairly quiet in the last few days amid the lack of any major macro catalysts. Investors still seem 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 some reports suggest authorities there are going to ramp up their efforts - which is why the euro has shot up this week.
One source of concern that has not materialised yet but may come back to haunt investors is the potential for inflation to overshoot in the coming months 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. Stronger economic growth should boost earnings and revenues of US companies.
However, the key risk is if inflation turns out to be longer lasting rather than a temporary shock. This would require the Fed to be more aggressive in tightening its belt.
But policy makers at the Fed don’t think that is going to the case. 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.
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, I reckon 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 as they continue to make new highs. It is interesting to note that the AUD and CAD etc. have started to break down already against the US dollar. Crude oil has been struggling for direction, along with copper. Equities could be next.
S&P 500 rally near exhaustion?
The S&P 500 is testing the upper resistance of the rising wedge pattern currently. Given the strong bullish momentum, a continuation higher cannot be ruled out. But what I am interested in seeing is whether the breakout will fail, and we go back below the trend line. If that happens, we could see a sharp drop to at least the support trend line of the wedge pattern in the days ahead. It is worth pointing out that Relative Strength Index (RSI) indicator is at overbought levels of around 70.
Source: ThinkMarkets and TradingView.com