S&P drifts lower
US stock index futures drifted lower in early trade this morning, indicating a weaker open. This follows on from yesterday’s trade which saw all the US majors close in negative territory despite early strength. Attention has turned back towards the US/China trade dispute after President Trump said yesterday that he was holding up a deal with China and had no interest in moving ahead unless Beijing agreed on as many as five “major points.” While the president declined to say what these are, it’s understood that issues over intellectual property are perhaps the most contentious and difficult to resolve. Trump and Chinese President Xi Jinping are expected to meet at the G20 meeting in Osaka at the end of this month. While a resolution to the trade dispute would be market-positive, tariffs have already taken a toll on global economic growth, and global trade is already falling back to levels last seen ten years ago during the financial crisis. Trump also lashed out at the US Federal Reserve saying that rates were “way too high” and leaving the dollar at a competitive disadvantage.
Fed goes full-Dove
After the disappointment of May (the month, not our ex-Prime Minister) which saw the S&P fall over 7% from an all-time record high above 2,950, investors rushed to ‘buy the dip’ as June got under way. The initial trigger for the rally was provided by a succession of Federal Reserve members, led by Chairman Jerome Powell, indicating an openness to cut rates. Members cited the risks to economic growth posed by global trade tensions as well as weak US inflation, something that only recently Jerome Powell was describing as ‘transitory’. Also, last week Powell stated that the Fed's unconventional tools are now conventional and will "likely be needed in some form in the future". This suggests that a return to ZIRP (Zero Interest Rate Policy) or even QE (Quantitative Easing) could be employed again, possibly in the near-future.
Sunday brought news that the Trump administration had reached an agreement with the Mexican government over policing the border between the two countries. President Trump said that a 5% levy all Mexican imports into the US was suspended indefinitely. This initial tariff (which was set to rise to 25% by October) was due to kick in at the beginning of this week. Ahead of this, Friday brought the release of a truly awful Non-Farm Payroll release which convinced traders that the Fed will need to loosen monetary policy aggressively. The fed funds futures market is just one of many interest rate contracts suggesting that the Fed could cut rates by 75 basis points before the year-end with the first 25 basis point cut to come in July, despite there being a Fed meeting next week. This is a big quarterly meeting when the Federal Open Market Committee (FOMC) releases its latest Summary of Economic Projections. Nevertheless, market participants believe the Fed will hold off until the following month. By then we will have had the latest updates on payrolls and inflation, together with second quarter GDP. Of course, there’s the danger as far as equity bulls are concerned that the data is better-than-expected, making it difficult for the Fed to ease. But long-term investors should bear in mind that we’re a very long way into the economic cycle. Bad numbers are bad numbers, and ultimately the Fed can’t fight off the business cycle forever by reducing interest rates, or reintroducing quantitative easing. What worked back in 2009 with the stock market at generational lows in the trough of the cycle, won’t work now at all-time highs and with global growth slowing.
The sharp snap-back which followed the sell-off in May appears to have stalled for now. As we can see from the chart above the S&P has failed to hold above 2,900. Also, the candles that formed on Monday and Tuesday with small bodies and long wicks and shadows suggest indecision on the part of traders. The question now is whether we’re in for a period of consolidation before pushing higher (bear in mind that the 50-day moving average hasn’t been breached to the downside) or if we’re about to experience a corrective pull-back which has the potential to gain downside momentum.
The chart above shows how the S&P pulled back sharply yesterday from 2,908/9. This level marks the 78.6% Fibonacci Retracement of the May sell-off. If the index recovers its footing and manages to break above here this week, then a retest of May’s all-time high looks like a possibility. However, if traders decide to book profits given June’s rally to date, then a pick-up of downside momentum could lead to a bigger pull-back.