Could have been worse

Risk appetite is better this Monday morning than it was last Friday when the world was bracing for the Iranian retaliation on Israel. Iran fired more than 300 drones and missiles on Israel on Saturday night, but only a small number reached Israel, limiting damages. There were no fatalities, just an army base was slightly damaged. Good news is Teran called the operation a success and declared that it won’t take further actions unless Israel responds. Oil traded slightly lower as the first reaction to the weekend news, while gold gapped higher at the open as last week’s rising tensions left a sour taste in investors’ mouth. Elsewhere, base metals including copper, iron and aluminum surged after the US and the UK decided to impose sanctions on Russian supplies. Spot aluminum jumped more than 5% while copper futures advanced to the highest levels since last summer. The dollar index consolidated on Monday after a 2% jump last week.

Too strong to cut

The US dollar strengthens on the back of a severe deterioration in Federal Reserve (Fed) rate cut expectations following strong jobs and inflation data, and the dollar outlook remains comfortably bullish.

The US 2-year yield hit 5% post-US CPI data, and the probability of a June Fed rate cut fell to around 22%. July cut expectations is around 50-50, and a September rate cut is given around 73% chance.

And you know the election narrative that the Fed may not opt for a rate cut approaching the November presidential election, which would delay the first cut to after the election. And some believe that the Fed’s next move won’t be a cut, but a rate hike to tame rising inflationary pressures. That’s a significant readjustment compared to the expectation of six rate cuts in January.

Diverging fortunes

While the US data continues to cement the strength of the US economy and the fact the US doesn’t need to cut rates – and should not be cutting rates with heating inflation - the rate cut expectations elsewhere remain pretty solid. Last week’s European Central Bank (ECB) meeting gave another hint that the bank will more likely than not cut its own rates in June. ECB Chief Christine Lagarde said that the ECB is data dependent and not Fed dependent and other members noted that it’s time to ‘diverge’ from the Fed, as the US consumers are relentless – and the US government is very supportive – with Biden looking to cancel $7.4bn in student debt to please young voters before the election.

As a result, the gap between the Fed and the ECB rate cut expectations widened to the highest level this year following a dovish ECB stance and another set of strong jobs and inflation read in the US. And the chatter of a further euro depreciation to parity against the US dollar is being brought back on the table. At the current levels, the RSI indicator is very close to the oversold territory, meaning that the euro was sold too rapidly in a too short period of time and a correction could be needed. But most traders will be looking to sell the tops in the EURUSD on the back of the growing divergence between the soft ECB and the Fed – that simply can’t justify a rate cut this summer.

Earnings

The S&P 500 posted its worst weekly performance since late October 2023. Mixed bank earnings didn’t help improve mood on Friday. JPM tanked 6.5% as net interest income missed expectations and slipped from the previous quarter as investors chased higher returns. The latter is a real joy killer among investors who were expecting to hear how much more net interest income the bank could gain with a delayed rate cut from the Fed. Similarly, deposits that don’t pay interest at Wells Fargo slumped 18% in Q1

This week, the earnings season gains momentum with the rest of the US big banks, Netflix and TSM due to announce their Q1 results. The expectation is a 3.8% annual growth in S&P500 companies’ earnings per share in the Q1, while profits for the Magnificent Seven are expected to have risen around 38%. Another strong quarter in terms of earnings could slow a potential selloff in the S&P500 – that sees the selling pressure rise on the back of rising hawkish voices. But a softer-than-expected earnings season will likely trigger profit taking.

Halving

Bitcoin slumped over the weekend as rising geopolitical tensions weighed on risk appetite. Bitcoin halving is expected to happen in the coming days. Lower supply is fundamentally supportive of an asset’s valuation, but we might not see a clear kneejerk reaction to Bitcoin halving as most of it is already priced in.