Forecast. Macroeconomic Situation. Federal Reserve. Forex
Markets are driven by central banks when it comes to price action. We got the FOMC—inflation must decrease dramatically before they abandon their tough stance.
The Fed won’t cool down just because markets are falling, while reports provide numbers that don’t match their forecasts. Price stability is at the core of the whole thing. Consequently, there must be +4%. Otherwise, we’ll see a catastrophe. The broader markets have finally figured that out. A conviction is growing that the U.S. will fall into recession.
MUFG’s latest report directly concerns the forecast for the stock market and Forex. Let’s take a look at the key insights.
Volatile Q3 sets up for challenging Q4. Investment grade credit rating (IG U.S. Index)
1. From mid-July to mid-August, we saw a severe market rally.
✔Q2 revenues, which were mostly better than expected;
✔the Fed raising the rate by 75 bps on July 27 and expectations of higher rates;
✔a lower CPI as of August 10.
2. By August 16, the S&P 500 was up 13.6% compared to mid-July, and the IG index was up 22 bps unexpectedly (from 153 bps to 131 bps). Nonetheless, this rally was short-lived: both markets declined from mid-August to mid-September.
✔Powell’s comments were too harsh (fears of further rate hikes and recession risks);
✔a stronger-than-expected CPI report (inflation isn’t yet under control);
✔China’s GDP growth slowing down;
✔several economic reports, which did show decent growth.
3. By mid-September, the S&P 500 has dropped by 12% since mid-August to $3,790 (the lowest level since July 14). Spreads for the IG index are up by 14 bps up to 143 bps (the highest level since the beginning of August). The S&P 500 is down 20% since the beginning of the year.
4. Volatility proves that the underlying market risks haven’t changed over the past six months.
✔persistent signs of high inflation;
✔disrupted supply chains;
✔the Russo-Ukrainian War;
✔an escalated situation between China and Taiwan;
✔raising rates and shrinking the Fed’s balance sheet through a quantitative tightening (QT) process.
Forex. Key risk factors expected in the coming months
Considering yesterday’s events, one of the risks is that the Japanese government’s interventions will be more successful than expected. If the Japanese Ministry of Finance continues to support the yen, this plan could have a robust impact in the long run. It seems unlikely yet risky, given that the intervention got confirmed suddenly—only yesterday morning.
A faster tightening of financial conditions, i.e., a sharper fall in U.S. stock markets, could change rate hike expectations more abruptly, resulting in USD/JPY going lower than expected.
All in all, the key upside risk to the EUR/USD bearish outlook may come from a further easing of acute energy supply issues in Europe. If gas prices continue to decline ahead of winter, this will help ease fears of a sharper slowdown in the eurozone.
At the same time, the euro could stand stronger than expected if the ECB keeps raising the rates faster (while the Fed signals that it sees slowing down the pace as an option).
The downside for the Chinese yuan could be a worsening COVID-19 situation and continued pressure from the real estate sector. The government will shortly have to provide positive expectations for households and corporations.
Fed’s rate hikes are another risk in this case.