CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 69% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 69% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

Fed minutes unlikely to derail risk rally as markets wait for Trump

Article By: ,  Financial Analyst

The US roared back into life after the long Presidents’ Day weekend, and US equity indices hit further record highs on Tuesday. This is becoming so regular it is barely news. But for those predicting the market’s demise beware, a Bank of America Survey found that historically the 6-months before the end of a market rally produces returns close to 15%. So, even when markets look over-priced and ripe to fall, the market can still push higher.

What to expect from the FOMC meeting

Wednesday’s key market driver is likely to come after the European close, with the release of the FOMC minutes from its meeting that concluded on 1st February. While we have already heard from Janet Yellen since this meeting, there could still be some market-moving nuggets included in the minutes. While the market pretty much expects the Fed to express greater confidence in the inflation outlook, two things to watch out for include: 1, how many members, especially voting ones, are likely to vote for a rate hike in March, and 2, just how detailed is the Fed’s discussion on shrinking its balance sheet.

Philly Fed getting ready to vote for a hike in March

Voting member Patrick Harker, Governor of the Philadelphia Fed, said on Tuesday that he could vote for a rate hike in March, will there be others like him? If yes, this could trigger the move higher in bond yields that we didn’t see after Yellen’s relatively hawkish commentary to Congress last week. Higher bond yields = higher dollar, so the FX market could be the one to watch on the back of these minutes.

The one thing that seems to be holding the Fed back from committing to hiking rates, even though inflation is rising and the economy is strengthening, is uncertainty around the political and fiscal outlooks. We expect the minutes to reiterate the high degree of uncertainty regarding the fiscal outlook under the Trump administration, but we don’t expect anything other than this bland statement. Essentially, Trump is the tail wagging the Fed’s dog, and at this stage the Fed has to be reactionary to Trump’s plans, which should be announced in more detail when the President addresses Congress next week. For now, we expect Harker to remain one of the lone voters looking for a March rate hike, which could temper any move higher in bond yields.

Why markets aren’t worried about rate hikes, yet…

We doubt that the Fed minutes will upset the rally in stocks in any meaningful way. Even if we see a slight rise in Treasury yields on the back of the minutes, we doubt that they will shoot high enough to weigh on equities. A leading US stock market indicator, the Russell 2000, also hit a record high on Tuesday, at the same time as its valuation indicator touched a record level. This suggests that, at this stage of the market rally, investors are not worried about high valuations. Instead they are carried away on a wave of optimism about the economic outlook under Trump. The data to support this comes from the JP Morgan Business Leaders Outlook survey, where 80% of mid-sized businesses are optimistic about the future under Trump, compared to 39% a year ago. 12% of businesses had a negative view of Trump because of the impact of potential trade wars.

France’s election catastrophe: Le Pen and the end of the euro

On the other side of the Atlantic there is a very different picture. No one seems optimistic about the political future. Marine Le Pen in France is now the front-runner to win the first round of the French Presidential election, and her prospects are also improving for the second round. This has caused the spread between French and German yields to surge, and we expect this to continue. Political risk also weighed on the EUR/USD, which managed to hold above key 1.0500 support but still looks vulnerable as victory for Eurosceptic Le Pen could spell the end for the single currency.

US trumps UK banking sector in earnings season

Another area of difference with the US is Europe’s banking sector. Big losses for HSBC and yet another investigation into money laundering, weighed on the bank’s share price on Tuesday, it fell nearly 7% and showed no sign of recovering by the time the market closed. This is just one of many European banks currently in trouble, including Deutsche Bank and RBS. The Q4 2016 earnings season is highlighting the structural decline in investment banking in Europe. While the banks that have reported so far in the UK have registered negative sales growth, and some have reported dismal profits, the performance of the financial sector in the S&P 500 was strong with positive earnings and sales growth. This contrasting performance could fuel further gains in US financial equities at the expense of their European counterparts.

Overall, the markets are still in euphoric mode in the US, and we doubt this will be disturbed too much by the Fed minutes. At this stage, all eyes are on Trump’s address to Congress (a State of the Union type event) that takes place next Tuesday. A lot of market expectation is riding on this, if Trump fails to deliver then this could be when the equity market’s house of cards could come tumbling down.

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