Tuesday, 25th September 2018 13:06 - by Shant
It has been a common cry - or complaint - lately that the markets are all moving in one direction in recent months. Everything is skewed towards US assets, including more specifically, the Dollar. As a result, commodities markets and emerging markets have been the hardest hit, with the added pressure of the Dollar gaining safe haven status as the US continues to wage its trade war with China.
On this, there has been little relent, though perhaps cynically, one would expect this from president Trump, who wants to maintain a strong policy stance and persona going into the midterm elections.
This has all been backed up by strong economic performance out of the US, which has received a tailwind from the tax cuts initiated at the start of the year as well as a weak Dollar which has since reversed with revenge. Tailwinds are clearly finite, and even though the effervescent US equities market needs little encouragement, the greenback has been giving back a little ground, which again, technically makes US stocks cheaper and another reason to keep the 'bull train' on Wall Street chugging higher. Everything points to maintaining the status quo, and we can see speculators are happy to do this, with complacency over global risks at an all-time high.
Despite coming out of the summer doldrums, there has been little to suggest that directional conviction has picked up. As we continue to monitor the relationships between the various asset classes, all we can see is a continuation of positive risk sentiment as a function of preference for yield first and foremost. Gold prices are trying to base out, so perhaps some of the leveraged (US) yield-seeking has played through here, though the carry trade is very much alive and kicking as the Japanese Yen is pressed lower still. The BoJ is not about to give up on its quest for inflation pick up, and as a result, we have yet another source of fuel to US markets albeit through ETFs. While excessive positioning in these new derivatives is a topic within itself, we will stick to the underlying driver that is the US economy and Fed policy thereon.
As a 25bp hike is all but fully priced in, the focus will be on the projections - or dot plot - which currently err on the side of a fourth hike this year - in Dec - with odds for this currently close to the 70% mark. While there is a risk (small as it is) that a Dec move could be dampened in order to give the Fed some breathing space, we also get the first estimates for 2021 which will naturally offer insight into where the Fed see the long-term neutral rate topping out. Much has been made of the flattening yield curve but to little ill effect on stocks. The view that this preempts a recession in the US sooner rather than later has been dismissed with the notion that it is 'different this time'. Time will tell in terms of the real economy, but as has been evident for some time, the correlation with stock markets is tenuous at best!
So what will or should investors be looking out for? For one, the Fed's assessment on whether they continue to see policy as 'accommodative' should be an indicator - on the rate path if nothing else. Sticking to this line in the statement would signal an upward bias on rate hikes albeit to a modest degree. Such is central bank scrutiny these days that we are left hanging on the mere admission or omission of words in forward guidance, and here we have one of the key risks to look out for come Wednesday night.
Second are the Fed estimates for 2021. Should the projections level off in the 3.25%-3.50% area, we sense US equities will take heart. Earlier in the year, there was widespread belief that with long end rates above 3.0%, investors would be inclined to readjust portfolios in favour of Treasuries. As we know from market positioning, speculators are happy to stay short which in turn feeds the traditional dynamic. In noting this, we would suggest that this level of positioning also highlights a risk in itself going into the Fed meeting.
Finally, the Fed's view on US trade policy. This perhaps goes hand in hand with the previous point as a source of restraint despite economic strength. Over recent weeks, we have finally seen some movement towards fears that the trade wars will impact on the US to some degree, though once again, the correlation between how this will impact on the real economy, interest rates and stocks becomes a little trickier to discern - though stocks seem to shine whatever the weather.
The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.