Stock market stabilization points to less cautious investors

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Markets

US stocks rose on Friday, the S&P rose 1.2% on Friday to be up 6.2% for the week: best result since November 2020. Oil up 1.3% on Friday, but down 1.3% on Friday. 4.2% over the week.

Stabilization of stock markets indicates less cautious investors. Not because views on geopolitical or political/rate risk have improved, but because price action shows a market more forgiving of these challenges.

Monetary policy is still relevant to markets, but has taken precedence over the multi-asset impact of the Russian-Ukrainian war.

However, it should be noted that initial rate markets are close to pricing in eight 25 basis point Fed rate hikes, seven on top of last week’s 25 basis point hike.

US 5-year and 5-year break-even inflation rates are in the upper range (2.30% to 2.45%), partly reflecting higher oil prices (up 3% this morning) and the Fed’s explicit acknowledgment of extremely tight labor market conditions.

At the same time, the yield curve continues to flatten (2s10s: 20bp). This matters not because flatter yield curves mechanically cause recessions, but partly because a tightening of financial conditions desired by the Fed is circumvented by the flattening of the curves; therefore, they may begin to increase language by 50 bp. With the Fed sitting on its hands too long before rising, key rates need to do more heavy lifting than long term.

Reflecting this momentum, 37 basis points are priced in for the May meeting, a move accentuated by recent comments from the Fed’s Waller and Bullard who signaled a preference for a 50 basis point rate hike at the next meeting. .

Oil

WTI and Brent have not had much respite from renewed tensions in the Middle East, both up more than 3% today. Media reports that the Houthis in Yemen targeted at least six Saudi sites with drones and missiles on Saturday night/Sunday morning, including some run by Saudi Aramco.

Provided damage reports remain subdued, the market will focus on China’s covid policy (negative price) versus the possibility that more Russian sanctions are already being practiced by Western buyers, which is a colossal risk. (positive price). But until there is better visibility on how the war will play out, markets will always be driven by sentiment.

Gold

Gold is a bit higher with Oil rising as commodities remain the ultimate macroeconomic hedge should inflation expectations become unanchored. While risky assets and fixed income securities should suffer in this environment, commodities should benefit.

Forex

The four major central banks have tackled the same inflation problem but with four different moves. The Fed is all against inflation, seemingly willing to risk it causing the economy to crash into a hard landing. The ECB presented a glide path on the withdrawal of the APP that will allow it to unwind negative rates – the communication was likely much more hawkish than the planned policy intentionally designed to support the euro.

The BoE was much more dovish than the market was pricing in, but was very much in line with recent forecasts – it just wants to control inflation expectations. The BoJ was more concerned about the economic damage caused by high energy prices and will encourage economic growth rather than fighting inflation anxiety.

Curiously, international investors ultimately see the four stock markets upside down. A positive attitude towards the United States, the beginning of another negative outlook on Europe, the return to concern about the damage caused by Brexit in the United Kingdom and complete ignorance of Japan.

The S&P is the market most likely to capture investment flows, but FX traders are watching the curve, signaling later in the year that US markets will be most at risk from an economic hard landing. Therefore, I think the dollar will struggle to regain its former glory this week, although a series of hawkish speeches from the Fed could tip the momentum in favor of the greenback.

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