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In January, market participants seemed to grasp the idea that the Fed was not joking about tightening its monetary policy. S&P 500, which reached its all-time highs at the very end of last year, fell to 4212 points by the end of January, where it formed a decent support level that bears will find difficult to overcome. Moreover, if they do not make this attempt in the first half of February, it will be possible to speak about the end of the correction with a high degree of probability.
As we already wrote in our blog, FOMC’s January meeting provided no surprises and no promises were given. We heard what we expected to hear: asset buybacks will end in March, an increase in interest rates seems acceptable, as is balance sheet reduction. The growth rates of wages, inflation and the economy were emphasized. FOMC plans to raise rates already in March and then, perhaps, at almost every meeting. Powell acknowledged that the Fed’s balance sheet is larger than it should be, while inflationary risks exist and are higher than initially expected. Thus, the Fed is ready to launch an aggressive monetary policy and stick to it until inflationary pressures begin to ease.
Chinese economy continued its slowdown with manufacturing stagnating, while the non-manufacturing PMI decreased by 1.5 points. January and February are usually slow production periods due to the Lunar New Year holidays. The government is seeking ways to stabilize the economy ahead of a key political leadership meeting later this year, with Central bank already cutting interest rates and officials pledging more fiscal support. In U.S. manufacturing activity also decreased (to a 14-month low), while applications for state unemployment insurance decreased for the first time in four weeks.
Eurozone manufacturing activity increased in January as supply chain bottlenecks eased. IHS Markit’s final manufacturing Purchasing Managers’ Index increased to a five-month high of 58.7 points. Raw material prices continued to rise, but at a slower pace than in December, and factories passed bigger share of that increase to consumers – the output prices index increased to 72.7 (the second-highest reading in almost two decades). Economic sentiment deteriorated in January – the European Commission’s economic sentiment index decreased to 112.7 points in January compared to 113.8 in December.
January followed our EUR/USD trade idea quite well – the pair poked 1.1450 area and then dropped towards our 1.1000 target. It appears that market places more credibility in Fed, as interest rate differentials favor the greenback. We still keep an eye on 1.1400-1.1500 resistance area for the pair with 1.1000 being a convenient support zone.
Energy and electricity prices continue to be the topics in our everyday life. There are so many reasons for oil to be expensive so we wanted to look at it from pure technical perspective. Medium-term price action from Covid-19 selloff is impressive, but technical perspective might not be that bullish in short-term. There is a great risk that oil is close to a cyclical top, form where we can expect a deep correction to 60 USD/bbl area.
John Maynard Keynes was once asked why he changed a prediction he had published a few months before. “When the facts change, I change my mind. What do you do, sir?” was his answer. Precious metals had so many chances to start (or rather continue) a long-awaited rally, yet they failed at every attempt. The fact that in such an environment (deeply negative real rates) precious metals continue to struggle makes us uneasy. We are quite happy with the long-term picture, but consider the probability of a sizeable short-term decline quite real.
Inflation is causing increasing headaches for not only consumers, but also central bankers. As we have already said, the Fed will be active this year in a hope of reducing the negative inflationary pressures on the economy. Of course, this cannot but affect the bond market. Participants have begun to position their investments in line with expected restrictive monetary policy, which has had a negative impact on benchmark bond prices. The market is also unsure of exactly how and when the Fed will deliver on its promises. As long as this uncertainty persists, financial markets will be subject to increased price volatility.
It is expected that the dynamics observed in the fixed income markets in recent months will continue, when benchmark bonds will play the main violin and other market segments will follow, especially investment grade bonds.
Until now, high-risk bonds were more protected from rising benchmark rates as they benefited from a generally positive market sentiment. In January, when sentiment towards risky assets changed, high-yield segment was hurt. In addition, emerging market bonds are also affected by geopolitical risks, which are currently most pronounced in Eastern Europe.
As expected, the markets did not like Powell’s “confessions” and we saw stocks, bonds, and precious metals drop. We are not in a hurry to “buy the market”, but we have begun to add to some positions. Yes, we may see another wave of selling, but levels below 4400 in the S&P 500 are convenient for long-term buying. As convenient as were the levels above 4700 points for profit taking at the end of the previous year. We do not want to get ahead of the market, but already the first half of February might show signs of the formation of a “market bottom”, which will signal the end of correction.