Portuguese markets were hit yesterday by the resignation of the country’s PM following an investigation into possible crimes of corruption involving lithium and hydrogen projects. The Portuguese PSI 20 fell more than 2.50% on political jitters and uncertainty. But the scandal didn’t resonate much in the rest of the European indices – which were little changed yesterday. The Stoxx 600 remained offered at the 445 level, which is an old support that turned resistance. The outlook remains negative due to the slowing European activity, and the EUR/USD slipped below the 1.07 mark as the US dollar extended its gains for a second day.
Whatever
Yesterday was quite interesting in terms of the Federal Reserve (Fed) talk and the market reaction to the Fed talk. A few Fed speakers including Neel Kashkari and Michelle Bowman sent a cautious message to the market that the Fed’s battle against inflation is not won yet and tightening could continue. But in vain, the market reaction to the latest comments from the Fed speakers was a thick and determined ‘whatever’. The US 10-year yield fell below its 50-DMA, the 2-year yield steadied below the 5% mark, and the gap between the two is widening again as the dovish Fed expectations swamp the marketplace following the soft US jobs data released last week in the US and the Fed’s decision to pause for another month. The Fed President Powell is due to speak this week and will certainly say the same thing as his dear colleagues: that the Fed’s fight against inflation is not done yet and that they will watch the economic data to decide what’s the next step – which could be another pause or a hike – but investors have made their mind and trade confidently on the expectation that the Fed is done hiking.
Now, I also think that if we don’t see inflation numbers take off, the Fed is gently done hiking. But the excess optimism in the market, and the falling yields will get the Fed to firm up its stance to make sure that the financial conditions don’t ease too fast too soon. A 50bp fall in the US 10-year yield and a strong rebound in the equity markets is not good for taming inflation. Therefore, I expect the bond rally to start slowing approaching the 4.50% level in the 10-year yield, and expect the 2-year yield to return above the 5% mark.
In equities, the S&P 500 is above its 50-DMA for the 3rd day and the rate-sensitive Nasdaq 100 broke above its summer down-trending channel top. At the current levels, the S&P 500’s earnings yield is around 4%, and the Nasdaq is around 3.70%. That means that the Fed should proceed with a couple of rate cuts and the sovereign yields should fall significantly more for these returns to look appealing in comparison. That’s why the equity rally doesn’t look like it’s on solid ground. Non-cyclical, value names are preferable. US equities could continue to outperform the European and Chinese peers.
Crude Oil Below 200-DMA
The barrel of crude oil fell almost 5% yesterday after the $80pb support gave in to the growing weight of the increasingly aggressive bears. The price fell below the 200-DMA, near the $78pb, in a swift move, and is consolidating below this level this morning. Trend and momentum indicators remain comfortably negative, but the RSI warns that crude oil is about to step into the oversold market territory and that it will soon be time for a correction. Buyers are expected to come in at the $75/77 range, and a correction to $80/82 range is possible, with limited upside potential above that level. The risk of a sudden jump due to supportive geopolitical news is live, but if the Gaza war, the Iranian warnings that the war could escalate and spill to the region, and OPEC and Russia’s reminder that they will keep the production levels tight couldn’t prevent this month’s selloff, the slowing demand rhetoric will continue to outweigh the supply concerns and keep the market in the bearish waters. US crude remains in the bearish trend below the $85pb level.