Weekly Outlook

By David Morrison  |  05/03/2018 10:15

This article looks at the week ahead for US stock indices, FX and crude oil

Summary

This is a big week for financial markets. Last week there were some highly significant moves which saw the major US stock indices break below important support levels. Of note, despite a late rally on Friday, the S&P 500 closed below both the 50% retracement of last month’s sell-off and the 100-day simple moving average at 2,695. From a technical perspective, this suggests that US equities could struggle to recover more of February’s losses.

Yesterday saw members of Germany’s SPD party vote overwhelmingly in favour of going into coalition with Chancellor Merkel’s CDU/CSU political grouping. This is unequivocally good news as it means that Germany will now have a functioning government after a five months gap since the General Election. The euro rallied initially on the news as the alternative would have been a fresh election with all the uncertainty that would have caused - not just for Germany but for the European Union. But the rally was short-lived as traders reversed their positions as the results of the Italian General Election filtered through. As expected, there’s no clear majority for any one party although the anti-establishment 5-Star Movement appears to have won the biggest share of the vote. However, 5-Star are refusing to go into coalition so we can now expect weeks of wrangling as parties try to form a workable government and agree to key appointments.

At the beginning of last week, the dollar rallied sharply as new Fed Chair Jerome Powell delivered what was largely considered to be hawkish testimony in Washington. Many observers left convinced he was hinting that the Fed could raise rates by 100 basis points in 2018, up from the 75 basis points forecast by the FOMC in December. On Thursday New York Federal Reserve President Bill Dudley stated that four 25 basis-point rate hikes “would still be gradual”, further boosting the greenback. But later that day the dollar sold off sharply after President Trump said that he would be instigating tariffs on US imports of steel and aluminium in a move which many expect will result in an all-out trade war.
This week we have monetary policy meetings from the Bank of Canada, Reserve Bank of Australia, Bank of Japan (BOJ) and European Central Bank (ECB). Of these, it is the latter two which are of greatest importance. Last week a story in Reuters said the ECB was hoping to delay announcing any further reduction in its Asset Purchase Programme which is currently expected to finish this September. In the absence of any clear reference in its statement, the ECB President Mario Draghi is bound to quizzed on this in his subsequent press conference.

Meanwhile, at the end of last week BOJ Governor Haruhiko Kuroda announced that the central bank would begin planning an exit from its monetary stimulus programme around April next year. He went on to say there could be a policy change before the BOJ’s 2% inflation target was reached. The announcement was unexpected, particularly as Mr Kuroda has refrained from any prior comments concerning monetary tightening. Japanese investors took fright and the Nikkei ended Friday’s session 2.5% lower. It lost a further 0.6% during Monday’s session.

At the end of last week, the DAX30 slumped and came close to hitting a 1-year low. Investors were spooked by the prospect of trade wars breaking out following Trump’s tariff announcement and the negative effect on the export-driven German economy. The DAX ended the week hovering around support at 11,800 which marks the 50% retracement of the November 2017 – January 2018 rally.

This Friday brings the latest update on US Non-Farm Payrolls. The consensus expectation is for an increase of 204,000 – just a rounding error above last month’s 200,000 reading. But, in the absence of a substantial miss to either the upside or downside, this will be of lesser importance than average hourly earnings. It was last month’s +2.9% reading (way above the 2.6% expected) which triggered inflation fears and catalysed a jump in volatility and the stock markets’ corrective sell-off. Another strong number will add weight to the argument that the Fed will opt for four 25 basis-point rate hikes this year.

Stock indices

Global stock indices were tumbling at the end of last week. The generalised sell-off was triggered by a number of factors including President Trump’s decision to impose tariffs on imports of steel and aluminium, hints that the Bank of Japan is looking to wind down its programme of Quantitative and Qualitative Easing and perceived hawkishness from Federal Reserve Chairman Jerome Powell following his testimony in Washington. These negative factors all came in a week when investors were already rattled by the stock market slump at the beginning of February which brought the seemingly endless rally in equities to a shuddering halt. Back then, US Treasury yields spiked higher (as bonds sold off) on fears that inflation was about to take off. This raised concerns that the US Federal Reserve was falling behind the curve when it came to tighter monetary policy – particularly given the low level of US unemployment. Suddenly, it looked as if the Fed may have to raise rates by 100 basis points in 2018 rather than the 75 basis-points forecast back in December. These fears of an increase in inflation first came after Average Hourly Earnings came in at +2.9% - well above the +2.6% anticipated. This is important as we get the latest update on this number along with Non-Farm Payrolls this Friday.

As far as US stock indices were concerned, the “buy-the-dip” strategy has proved extremely profitable for most of the last nine years, and particularly so since the US election in November 2016. It has therefore come as something of a surprise to investors that it isn’t working so well now. Perhaps the main reason for this is concerns that all the major developed world central banks are preparing to withdraw monetary stimulus as they build up ammunition for when an inevitable downturn hits. On top of this, there are worries that the Trump administration’s fiscal stimulus in the form of tax cuts, regulatory reform and proposed infrastructure spending will prove to be inflationary, while driving up both the budget deficit and national debt. This in turn will force up bond yields which will not only weigh on growth going forward but will prove to be an intolerable burden for over-indebted corporations and individuals.

FX

The US dollar was sharply higher at the beginning of last week in a move which saw the Dollar Index surge through resistance around 90.00. The rally followed new Fed Chair Jerome Powell’s testimony in Washington which was considered more hawkish than anticipated. Mr Powell said he’d become more optimistic about the outlook for US growth and employment, and expected inflation to pick up. He hinted that he may look to edge up his forecast for rate hikes through the rest of this year.
But the greenback sold off sharply on Thursday after President Trump announced the imposition of tariffs on US imports of steel and aluminium. This move triggered fears of a trade war breaking out if US trading partners responded with tariffs of their own. On Friday Trump upped the ante by threatening “reciprocal taxes” with the US taxing imported products at the same rate as other countries tax US exports. Mr Trump explained that this was not only fair, but vital given the US’s $800 billion trade deficit. However, this would be yet another cost to US consumers which would feed through to higher inflation.

As far as the EURUSD was concerned, the late sell-off in the dollar meant that 1.2200 continued to hold as support. This was despite some nervousness earlier in the week which saw investors scale back their euro exposure ahead of the Italian General Election and as members of Germany’s SPD party voted on going into coalition with Chancellor Merkel’s CDU.

Crude oil

Crude oil fell sharply last week in a move which saw both WTI and Brent retest significant support levels. WTI fell back towards $60 which took it into the middle of an area which acted as resistance between April and June 2015. Brent dipped below $64 and looked on course to retest support around $62. Crude sold off sharply after President Trump announced his intention to institute trade tariffs on imports of aluminium and steel this week.

To some extent, Trump’s decision should come as no surprise. He promised such measures as he campaigned for the presidency as a way of protecting American manufacturing jobs. However, the excuse for taking this move now is national security with the White House saying that dependency on foreign steel and aluminium could threaten the US defence industry.

The market is only now waking up to the reality of the situation and how this could impact world trade. Certainly, the imposition of tariffs looks likely to see other countries retaliate and lead to an escalation of the trade war that has been gently fermenting for many years. On top of this, tariffs are by their nature inflationary which can only add to worries that the Fed may be forced to tighten monetary policy despite the ongoing sell-off in equities.

But oil was already falling before Trump’s announcement. Prices had pulled back on news of an unexpected build in US inventories. Meanwhile, US production continues to top 10 million barrels per day which continues to provide a headwind for prices. In the short-term, the path of least resistance could be downward, at least until the slide in equities is stemmed or there’s a retest of support.

Key events

Monday -             Chinese Caixin Services PMI; Spanish, Italian, French, German, Euro zone and UK Services PMIs; Euro zone Retail Sales; US Non-Manufacturing (Services) PMI
Tuesday -             Australian Current Account, Retail Sales, RBA Monetary Policy meeting; US Factory Orders
Wednesday -     Australian GDP, Japanese Leading Indicators; Canadian Trade Balance, BOC Monetary Policy meeting; US ADP Non-Farm Employment Change, Crude Oil Inventories, Beige Book
Thursday -           Chinese Trade Balance; Australian Trade Balance; German Factory Orders; ECB Monetary Policy meeting and Draghi Press conference; US Challenger Job Cuts, Unemployment Claims
Friday -                 Chinese CPI, PPI; Bank of Japan Monetary Policy meeting; UK Manufacturing Production, Industrial Production; US Non-Farm Payrolls, Average Hourly Earnings, Unemployment Rate.  

The fourth quarter corporate earnings season is winding down now but this week’s significant releases include Abercrombie & Fitch, Ashtead, Autodesk, Costco, Dollar Tree, Domino’s, HR Block, Just Eat, Kroger, Merck, Rolls Royce, Ross Stores and Target Group.
 
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