9 May 2022 - A FED-induced rally and then a slump


Our forecast that the FED meeting could produce a short-term rally worked … for one day. But sentiment remains fragile, and the “sell-the-rally” mode is still on, which caused on Thursday one of the largest daily drops for Nasdaq since the pandemic hit (-5%). However, US indices managed to post very small losses for the week with the exception of Nasdaq which registered a 1.5% drop. The forecast for a contrarian rally in the coming weeks still holds. Europe under-performed, with most indices down about 4%, as the EU is moving closer to an embargo of Russian oil and speculation on the next Putin move is escalating.


The FED raised rates by 0.5%, as widely expected. It also announced the commencement of its balance sheet reduction. However, the most important elements were to be found in the press conference. Mr. Powell mentioned a few significant points which should give us a guide for the markets, despite the noise that the volatility creates. He said that financial conditions have already tightened significantly and that the current market pricing of the 2-year bond probably discounts where the FED rates should be. The 2-year was trading close to 3% but dropped to almost 2.7% after his comments. Everything put together, one can conclude that the FED is not looking to raise rates more than 2.75%-3.00%, this year, despite the market speculation for an even more aggressive stance. Enough damage has already been done, was the main message.


The April CPI (inflation) number in the US is the most awaited macro of the week. It is expected to drop to 8.1%, on an annual basis, compared to the 8.5% of March. The monthly increase is expected to be just 0.2%, the smallest in many months. The “peak inflation” theme is going to have its first test.


The Bank of England raised interest rates to 1% and gave guidance for another two increases until year end. The Austrian ECB member said that the governing council will discuss a rate increase in June, a possibility that had not been discounted yet by the market, with July being the earliest of the forecasts.


The US labor market continued to show strength. The April non-farm payrolls rose by 428’000, more than expected and unemployment remained stable at 3.6% However, the weekly initial jobless claims have started to rise in recent weeks, so we could see some first signs of weakness in the labor market, in the summer months.


Economic activity in the US, however, continues to slow down. The April Manufacturing ISM index dropped to 55.4 from 57.1 in March, while Services also dropped to 57.1 from 58.3.


Government bond yields were mixed. The long-term rates rose significantly, while the short-term rates actually moved lower. The 10-year is trading at 3.15%, while the 2-year yield is around 2.7%, down from its high of almost 3%. The market is probably changing its views about how high the short-term rates can move and the yield curve is steepening. This is potentially good news.


Oil prices rose, as the EU is preparing an embargo for Russian oil by year end, although countries will have to be excluded (Hungary, Slovakia, Czech).


Gold has failed, once again, to capitalize on markets turmoil. It trades close to 1850$, down almost 10% from its recent high, which was registered at the early days of the Russian invasion.



Equities: Weekly Performance



Charts of the Week


Nasdaq has entered again its long-term trend channel

This is the chart of Nasdaq for the last 10 years, which shows a very well defined up-trend (green lines), compatible with the growth of Technology companies and their ever-increasing importance in our everyday lives. What is interesting is that the index in those 10 years has always traded within the upper and lower boundaries of this channel. What is even more interesting is that after the pandemic and the craze of investors about some Technology companies which led to various bubbles in the sector, the Index “flew out” of this trend (yellow region). This of course proved again to be unsustainable, in a similar way to the 1999 boom and bust. We are going through an ugly correction of the exaggeration which took place in 2020 and especially in 2021. The positive news is that the index is now back to its long-term channel and the downside looks to be limited to about 5-10% from current levels, while the upside is uncapped on a 3-5year time horizon.


The short-maturities US yields look very attractive

The chart shows the yield curve of the US Government Bonds and how it moved upwards from December (purple) to March (blue) and now (yellow), in just 5 months. The yield curve is a chart of the interest rates offered to the investor of a Government bond for various maturities, from a few months up to 30 years. If we were to concentrate on the short-end (left side) of the yield curve, one can see that the 1-year bond now offers almost 2% yield while the 3-5 years offer close to 3% yield. One can also notice that only 6 months ago, the yield on these 3-5 years maturities were closer to 1%. After the recent remarks of the FED’s Chairman J. Powell, it is very difficult to imagine that the yield of the short maturity bonds can move significantly higher than 3%, offering perhaps a unique entry point for USD investors. In the event of a recession hitting the US economy, having bought these bonds at these yields would also offer very decent capital gains.


Sources

Equities Performance: Factset

Chart 1: Factset

Chart 2: Indosuez Asset Management


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