|08 July, 2019

Fed monetary policy expectations dictating equity flows

Monte Safieddine is a market analyst at IG Dubai. He has spent nearly a decade in the FX industry and has held roles within financial firms that have included risk, analysis, statistics, and trading. Safieddine holds a Masters in Economics from Wayne State University where he completed multiple PhD-level fields and taught undergraduate students. He provides commentary on financial markets, including FX, cryptocurrencies and commodities, and publishes IG’s Daily Market Report and Weekly Market Report.

Website: https://www.ig.com/ae

Share prices are responding opposite to economic data as investors hope for monetary easing

Friday’s United States non-farm payrolls (NFP) figure was better than expected with the U.S. dollar outperforming compared to the FX majors and U.S. yields edging higher off recent two-year lows.

Money markets no longer expected three rate hikes for the year out of the U.S. central bank, with the majority pricing in two rate hikes by the end of 2019 instead.  Yet, despite a stronger NFP release, U.S. indices dropped from record highs posted earlier in the week and clarified the current market situation: monetary policy expectations are dictating equity moves, whereby rate cut expectations and anticipation of monetary easing work opposite decent economic data. 

In other words, positive economic data may actually hurt share prices if markets don’t expect as much easing out of the Fed, as it’s not the results of the data that matter so much, but how Fed policymakers will react to it, and whether it’ll match what money markets are pricing in for the future. 

And it isn’t just the U.S., as European indices have also been rising on anticipation of ECB easing as the bloc’s central bank keeps rates at 0% and German 10-year yields diving further into record negative territory, breaking -0.4% on Friday before retracing back up to -0.365% by the end of the session. 

Eurozone data has continued to disappoint, and yet European shares have risen instead.  Historically, in times of slow growth or recessions, money would pour out of the stock market and into safe haven assets, with the bond market a beneficiary of such flows. But with central banks buying up bonds and long-term growth concerns persisting, yields have turned (further) negative in parts of the world, and negative-yielding debt breaching $13 trillion in the process.

That, in turn, has made the stock market far more attractive in the hunt for yield, even if estimates for upcoming company earnings have dropped. Share prices usually rise on anticipation of easing, whether it’s due to expectations that the economy will be in better shape after the central bank’s prescription is taken, or as the hunt for yield gets tougher with interest rates plummeting and money is taken out of bank accounts and into riskier assets.  Lower interest rates should also make servicing rising corporate debt that’s at record levels easier, a concern cited by the Federal Reserve chairman Powell, who’s mentioned his monitoring of it. 

So, with the earnings season around the corner, would negative earnings actually aid share prices?  Perhaps not on an individual level, but collectively after the dust has settled, and if economic data worsens then rate cut likelihoods would rise, and future central bank easing prospects; potentially preventing share prices from plummeting. 

Furthermore, the disconnect between classic market forces that money managers have been accustomed to has forced those in search of returns to sidestep investment strategies for momentum-based ones, opting to move with the flow for limited returns instead of positioning themselves for a contrarian one as short indices positions get squeezed following record highs posted last week by the main U.S. indices. 

That makes understanding the current Fed outlook and reaction far more important, and with plenty of Fed speak this week be it Fed chair Powell testifying before Congress, other FOMC (Federal Open Market Committee) members giving speeches, or the central bank’s minutes released on Wednesday, the reaction in terms of Fed rate likelihoods will likely be more important in determining the direction of share prices as a whole. 

Any opinions expressed here are the author’s own.

Disclaimer: This article is provided for informational purposes only. The content does not provide tax, legal or investment advice or opinion regarding the suitability, value or profitability of any particular security, portfolio or investment strategy. Read our full disclaimer policy here.

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