Weekly look-ahead

By David Morrison  |  23/03/2018 16:59

Summary

Going into last week it was apparent that at least two significant markets, the US dollar and 10-year Treasury yield, remained rangebound. Meanwhile the tech-heavy NASDAQ hit a fresh all-time high while other major US stock indices traded at their best levels since the savage sell-off at the beginning of February.

Facebook rumbled

Then we saw evidence of investor nervousness as equity markets pulled back sharply on Monday and this set the tone for a bearish week. Facebook’s share price tumbled following reports that the social network had allowed a political consultancy to access the data of 50 million users. Why investors were surprised by the news is anyone’s guess. After all, Facebook doesn’t have value just because it pulls in advertising revenue, but also due to the personal data that it collects from its willing users, and ultimately what it does with this data. But the trouble for Facebook shareholders was this becoming public and (Shock! Horror!) that the data may have been used to help Trump clinch the US presidency. While Facebook CEO Mark Zuckerberg has been unloading stock recently, many fund managers will be regretting recent purchases as they have continued to add to their exposure since the sell-off in early February.

FAANGs slapped as well

Unsurprisingly, there has been a knock-on effect across all the tech darlings. The FAANG stocks (Facebook, Amazon, Apple, Netflix and Google (Alphabet)) have led the US stock market rally for years now. This is despite growing disquiet about the power and reach of these companies, their tax arrangements, monopolistic behaviour, lack of regulation and, in some cases, alleged exploitation of staff. The danger is that the selling now accelerates (particularly as much of the buying has been leveraged, which is evident given the large levels of margin debt in the equity market) as we approach the end of the quarter and a holiday-shortened trading week. On Wednesday Zuckerberg tried to deflect criticism of his company by calling for regulation to cover “ad transparency”. This would add costs to the company, and tech sector in general. But on the flip side, it’s generally the case that regulations benefit large organisations by making it harder for smaller companies and new entrants to challenge them effectively. As of Friday afternoon, Facebook was holding above support around $162.

Volatility remains elevated

Going into the weekend the sell-off across global equity markets showed little sign of abating. Facebook’s cavalier attitude to users’ data was just one symptom of a growing fear amongst investors that February’s correction may prove to be a harbinger of more pain to come. Bear in mind, volatility has picked up sharply. That’s to say it’s now getting back towards levels which better indicate the real risks inherent in the US equity market. At the same time, bond yields remain elevated as investors price in monetary tightening from the Fed and (eventually) other major developed-world central banks.

Other worries

Investors have also been unnerved by Trump’s trade tariffs and the prospect of a full-blown trade war. At the end of last week Trump hit China with $60 billion in tariffs. China is weighing its response and so far, it looks as if it could be muted. This is relatively good news as it suggests China is preparing a modest retaliation rather than a full-blown tit-for-tat trade war. But it’s early days. At the same time, there’s great concern at the staff turnover at the White House. Once again, this could be little to worry about, but it’s another factor playing into current investor nervousness. 

What about inflation?

The initial sell-off in bonds (and jump in yields) at the beginning of February came on the back of inflation fears. Last week the FOMC left its forecast for Core PCE unchanged in 2018 at 1.9%, but raised its outlook for both 2019 and 2020 by 0.1% to 2.1% for both. Core PCE has been steady at 1.5% annualised for the past three months and we get the next update this Thursday. But some analysts are now warning that fears of a sudden pick-up in inflation have been overblown. This was supported to some extent when Fed Chair Powell stated that there was “no sense in the data” that inflation is about to run away. If inflation shows signs of slowing again, then it may be that the 35-year bull market in bonds is set to resume and we can stop worrying about the 10-year yield hitting 3.0%.

FOMC steers steady path

Overall, the FOMC steered a steady path last week. Having raised rates by 25 basis points as expected, they stuck with their forecast of three rate hikes in 2018. But they raised their forecasts for 2019 and 2020, sensibly keeping their outlook balanced and options open. They also upgraded their outlook for employment and GDP growth. However, the Fed has a dreadful record when it comes to economic forecasts, although it’s not alone in this. It’s worth considering the Atlanta Fed’s GDPNow forecast. This is a “real-time” tracker which currently predicts first quarter GDP growth of just 1.8%. But this has fallen from 4% just over a month ago, which goes some way to illustrate the difficulty in economic projections, especially going out a year or more.

Dollar Index still rangebound

At first glance, perhaps the most remarkable thing about last week’s sell-off in risk assets was that the dollar continued to trade in a relatively narrow range – at least where the euro is concerned. While it sold off sharply following the Fed’s rate hike, statement and Summary of Economic Projections, the Dollar Index (which has a euro-weighting of 57.6%) continues to find support at 89.00 while being capped at 90.00. Looking at the EURUSD we find resistance comes in around 1.2400 with support still holding at 1.2200. The dollar’s price action is consistent with the moves in US Treasury bonds where (despite a brief breach last week) support is holding at 2.80% on the 10-year yield with resistance coming in around 2.95%. Higher yields are dollar-positive and so far, there’s little indication that the critical 3.00% level is in danger of being taken out anytime soon, particularly if equities continue to come under selling pressure and investors turn towards US Treasuries as a safe asset.

Yen rallies

But away from the euro, last week did see some significant currency movement against the greenback. The yen strengthened appreciably in a move which saw the USDJPY extend its losses below prior support at 108.00. It also appears that there’s little in the way of significant support now and a break below 104.00 would open up the risk of a move towards 100.00. But the USDJPY is very much a risk-on/off trade. Investors borrow (sell) the low-yielding yen when risk appetite is strong and use the proceeds to buy higher-yielding assets (such as US equities). But this trade can reverse quickly. Last week this was in evidence as investors dumped equities and bought back borrowed yen. Consequently, the yen should continue to strengthen if the equity sell-off continues. But any bounce in equities will see this move unwind fast.

Sterling in favour

Meanwhile, GBPUSD continues to push against the upper end of a trendline that’s been building over the last 15 months or so. Last week it broke above 1.4200 for the first time since the beginning of February and appears to have upside momentum. It also continues to make gains versus the euro with the EURGBP closing in on long-term support around 0.8700 – the 61.8% Fibonacci Retracement of the April-August 2017 rally. The Bank of England’s Monetary Policy Committee kept the base rate unchanged as expected, but is now forecast to raise rates by 25 basis points in May.
 
Key events this week

Monday -             GBP High Street Lending

Tuesday -             EUR M3 Money Supply, Spanish Flash CPI; USD S&P/Case Shiller House Price Index, CB Consumer Confidence, Richmond Manufacturing Index

Wednesday -     EUR French Consumer Spending, Spanish Flash CPI, German GfK Consumer Climate survey; GBP CBI Realised Sales; USD Final GDP and Price Index, Wholesale Inventories, Pending Home Sales, Crude Oil inventories

Thursday -           EUR German Preliminary CPI, French Preliminary CPI, German Unemployment Change; GBP Current Account, Final GDP, Net Lending, Mortgage Approvals; USD Core PCE Price Index, Personal Spending, Personal Income, Unemployment Claims; JPY Household Spending, Tokyo Core CPI, Unemployment Rate, Industrial Production

Friday -                 GBP/EUR/CHF/CAD Good Friday closures; USD Chicago PMI, Consumer Sentiment, Inflation Expectations
 
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