13/06/2022

THE PROBLEM OF INFLATION IS GROWING. WHAT THE FED WILL DO.

General Comment

With inflation in the US for May announced at 8.6%, the voices that inflationary pressures will slowly begin to subside, are visibly limited. That price is well above last month’s 8.3% and above market estimates. In this sense, the Fed’s meeting on interest rates and monetary policy next Wednesday is of particular interest. Estimates suggest a 0.50% increase in interest rates, with the FedWatch tool giving a 96.4% probability for this scenario.

With inflation persisting at these levels, the US 10-year yield will not stay at 3% for long. It should be remembered that this rise negatively affects all assets and especially high-risk positions.

In Europe last week we had the European Central Bank meeting on interest rates and monetary policy in the Eurozone. Interest rates remained unchanged and there was a commitment that the quantitative easing program would end early in the third quarter of 2022 and that a 0.25% increase in interest rates would probably be made immediately afterward. Christine Lagarde also released the bank’s revised growth forecasts, apparently down. There was an ambiguity about whether there would be a new rate hike in September and that of course came at the expense of the euro.

On the contrary, the Fed, with its determined and tight monetary policy and many interest rate increases, is creating an environment of strengthening the dollar.

Most equity markets fell sharply in the general climate of uncertainty brought by the war but also due to the aggressive policy of central banks that is expected to hurt liquidity. Gold ended the week with gains while oil remained unchanged near $120 per barrel. Bond yields jumped for the second consecutive week and the U.S. 10-year closed above the psychological threshold of 3%, at 3.16%. We need to underline that 3.20% is the highest price of the American 10-year bond in the last four years or so. Finally, the decline of Bitcoin and most cryptocurrencies is significant.

The week that has just begun has many important announcements. In addition to the Fed meeting, the announcement of inflation in the Eurozone, the announcement of interest rates in the United Kingdom, Japan, and Switzerland, and the announcement of the retail sales in the United States stand out.

SP500

The US SP500 index closed with a strong downtrend last week, at 3,908 points and losses that approached 4.90%. Fears and worries about slowing growth in the United States, or even a recession, trigger downward scenarios for equity markets. The high inflation rate of 8.6% announced for May indicates that inflationary pressures have not yet reached a peak and so the Fed will de facto be forced to toughen monetary policy further and not stop interest rate hikes.

Also, bond yields that are on the rise, especially the U.S. 10-year, make all assets more expensive, especially stocks whose value is based on future cash flows. So, stocks with high PEs like the shares of new promising tech companies are hit harder than the shares of established companies.

The index is very close to 3,800 points which is the most important support in this price range and is at the same time the lowest price since March 2021. A downward break in these levels may further accelerate the fall, with some analyses already referring to much lower price levels this year. We may try short positions this week.

DAX30

The German DAX40 index moved downward in the week that left, closing at 13,795 points, with losses of 4.70%. The DAX40 and most European indices are starting to align with the trend of the US indices as concerns about a recession in the economy that will be accompanied by high inflation are dominating. German bond yields are also on a strong upswing, with the German 10-year bond touching the yield of 1.50% which is a price we haven’t seen since 2014. This means that investors now have an alternative that provides relative security amid a war that no one knows how long it will last and what impact it will have. The economic announcements in Germany last week illustrate this fact since industrial production and factory orders had a sharply negative signs in April. 13,270 points is the most critical support for the continued downtrend of the index, and we prefer short positions this week.

FTSE100

The British FTSE100 index declined last week, closing at 7,344 points, with losses of more than 2.60%. Boris Johnson’s government, although it took a vote of confidence last Monday, was not convinced of its long-term viability. The UK is also affected by the financial crisis to the same extent as the rest of the world’s economies with recession scenarios dominating. These scenarios trigger increased chances for new interest rate increases by the Bank of England, while the minds of the investment community are dominated by the statements of the head of the bank a few weeks ago about a recession that will be combined with double-digit inflation. With this data, the bank’s meeting on Thursday takes on special weight. This explosive situation has driven investment sentiment to very low levels and is causing a big drop in British equity markets. Below 7,130 units it is possible to see stronger downward trends and any loss of 7,000 units can even lead to a free fall. We prefer short positions this week as well.

Gold

Gold was bullish last week, closing at $1,875 and gaining close to 1.20%. Gold seems to develop a slight upward trend from mid-May onwards, but without much intensity and strength. The high inflationary pressures and the major concerns caused by the war in Ukraine, lead many investors to the safe choice of gold. On the other hand, two major counterweights prevent the development of a stronger uptrend: the strengthening of the dollar (let’s not forget that gold is denominated in dollars) and the large rise in bond yields, which are also a safe-haven asset for investment and therefore a competitor for gold. If there can be a solid upward split above $1,880, we may see even higher gold prices so long positions is our selection for the current week.

US Oil

Last week was practically neutral for oil with next month’s futures closing at $120.35, with no special changes compared to the previous week’s close. High oil prices do not seem to have dampened demand and it is characteristic that in the United States gasoline stocks fell last week by 800K barrels. Oil prices also do not seem to reflect the recent increase in output from OPEC that was above expected and aimed at holding prices back. The only “dissonance” in all the factors that converge in the price rise, is a setback in China since the middle of last week, new restriction rules for dealing with covid began to apply. If there are signs that the new lockdown will have a limited duration and will concern just a few areas, then oil can continue its upward course. In contrast, below $118 the scenario of a local correction has a relatively increased chance. We prefer the second scenario, and we may try short positions this week.

EURUSD (Euro vs US Dollar)
Sharply bearish was the last week for EURUSD which opened at 1.0716 and closed at 1.0515. The high inflation announced in the United States makes the need for actions by the Fed stronger, and this is reflected in the strengthening of the dollar. The European Central Bank, on the other hand, seems more hesitant since the energy crisis and the war in Ukraine affecting European economies do not allow for such tight monetary policy and large interest rate hikes. In the rest of the economic news, the first quarter of 2022 had a positive sign for GDP in the Eurozone while the Michigan Consumer Sentiment Index in the United States had a value well below expected. The pair seems to be returning to its downtrend, which has been going on for about a year, having come very close to the price range of 1.0350, which is the lowest price in the last 5.5 years. We may try sell positions this week.

GBPUSD (Great Britain Pound – US Dollar)

Last week GBPUSD was bearish as it opened at 1.2487 and closed at 1.2312. The lack of economic news in the UK leaves room for the US dollar to determine the course and trend of the pair. High inflation in the US has greatly strengthened the dollar, pushing down the GBPUSD. The situation is aggravated, even if Boris Johnson’s government got a vote of confidence because a mini-political crisis is forming in the United Kingdom that raises doubts about the viability of the government in the future. This week contains many important announcements for the United Kingdom: of course, the announcement on interest rates and monetary policy by the Bank of England next Thursday is singled out, followed by the unemployment rate on Tuesday and the industrial production. The price range of 1.2150 is logical to be targeted by fans of the downward course for the pair since it is the most important support and the lowest price in the last two years or so and we’re keen to try sell positions this week.

USDJPY (US Dollar – Japanese Yen)

The USDJPY moved up explosively last week, opening at 130.85 and closing at 134.35, having gained about 650 pips in the last two weeks. The significant rise of the US currency in combination with the large increase in bond yields has brought this result. In this situation, of course, Japan’s weak currency is also advocated because according to most statements and analysts, Japan intends to continue its loose monetary policy and maintain negative interest rates. Japan’s GDP, as announced last Wednesday, performed better than market estimates, but that did little to help the country’s currency. The next bet for the uptrend of the pair is the area of 135 in which it was last found in early 2002. Any downward turn due to possible liquidation of profits could make some sense if there is an approach to 130 but we prefer buy positions this week as well.

EURJPY (Euro – Japanese Yen)
Bullish was the last week for EURJPY which opened at 140.27 and closed at 141.32. The euro developed strengthening trends after the European Central Bank meeting last Thursday after a pause in its quantitative easing program was announced and at least one rate hike was announced for the next period. On the opposite line, all statements from Japan converge that loose monetary policy and negative interest rates will continue since low inflation allows for this. The fact is, however, that the pair is at particularly high levels, perhaps in overbought conditions as it moves to the highest price levels of the last 7.5 years. This could lead to corrective scenarios, especially if there is a downward split below 140 so we may try sell positions this week.

EURGBP (Euro – Great Britain Pound)

Last week was bearish for EURGBP which opened at 0.8572 and closed at 0.8539. The pair was very close to the resistance of 0.8620 but it seems that at the moment the euro does not have the required strength that would lead to the breakout of this resistance and so there has been a shift towards the equilibrium point at this time which is close to 0.85. Given the important announcements in the Eurozone and the United Kingdom this week, high volatility is expected, and the downward scenario may dominate if we see an increase in interest rates from the Bank of England. Of course, the upward scenario is not excluded, if there is a rapprochement of 0.86. We may try buy positions this week.

USDCAD (US Dollar – Canadian Dollar)

Last week was bullish for USDCAD, which opened at 1.2594 and closed at 1.2785. According to statements from the Bank of Canada, a new increase in interest rates is expected in July by 0.50% and another increase in September by 0.25%, with the possibility of a pause from then on. This creates a divergence from the expected increases in interest rates in the US and thus develops an upward trend for the pair. In this situation, the pause in the rise in oil prices, which most often favors the Canadian dollar, was also advocated. The country’s most important announcement was on Friday concerning the unemployment rate and the labor market, with figures showing an improvement as unemployment fell to 5.1%. A further strengthening of the US currency could lead the pair to even higher levels, while if there is an increase in oil prices, we may see it fall to 1.25 again. We prefer buy positions for one more week.

USDCHF (US Dollar – Swiss Franc)
The USDCHF had an uptrend last week after the opening was at 0.9613 and the closing at 0.9876. The rise of the US dollar was sweeping especially after the announcement of high inflation in the US. The unemployment rate in Switzerland was unchanged in May at 2.2% but the big question mark is the attitude of the Bank of Switzerland at Thursday’s meeting. On the one hand, bank officials have repeatedly said that Switzerland is going its own way on interest rates and monetary policy, but on the other hand, pinched inflation of 2% may lead bankers to change attitudes. What is reflected, however, so far in the prices of the Swiss franc is that there will be no increase in interest rates without of course excluding the opposite case. As we get closer to 1:1, the upward scenario strengthens, and we need to see values below 0.98 for the corrective scenario to gain more strength. We may try buy positions for another week.

AUDUSD (Australian Dollar – US Dollar)

Last week was bearish for AUDUSD, which opened at 0.7209 and closed at 0.7042. Last Tuesday, the Bank of Australia raised interest rates by 0.25%, from 0.60% to 0.85% and this led to a temporary recovery of the Australian dollar, but it did not have the required continuity because of the strength of the US currency. In addition to this, the imposition of a new lockdown in China worsened the situation for the Australian dollar given the correlation and dependence between the two economies. If the US dollar continues to strengthen, then it is not ruled out that there will be a downward break out to the psychological limit of 0.70 so we may try sell positions this week.

Bitcoin

Last week, Bitcoin closed at $26,525 with losses close to 11.20%. It is obvious that Bitcoin is now strongly influenced by the performance of equity markets (especially NASDAQ100 stocks) but also the announcements of central banks and more of the Fed. After the announcement of very high inflation of 8.6% in the United States, a strongly negative investment sentiment developed that led to risk avoidance and safe-haven options selections that do not include Bitcoin and cryptocurrencies. The current week has opened with a strong downtrend, and Bitcoin is already in the price range of $25,500. The strongest support is close to $25,200 and a split could cause an uncontrolled decline, so we prefer short positions this week.

IMPORTANT DISCLAIMER

The information of this report is of a general nature only. It is not a personal financial advice. It does not take into account your objectives, financial situation and personal needs.

a-Quant is not responsible for your actions and recommends you contact a licensed financial advisor before acting on any information contained in this general information report.