Powell is not here to make equity investors happy

Appetite in Asian equities improved on hints that China could ease the excessive Covid curbs as a response to angry anti-Covid protests. 

Nasdaq’s Golden Dragon China index rallied 5% yesterday, even though appetite for the rest of the stocks remained limited, as few wanted to take a bet before Federal Reserve (Fed) head Jerome Powell’s speech due today.

What will Jerome Powell say?

Well, he will say that the pace of the US rate hikes will slow. But he will also say that the Fed is not done fighting inflation and that the terminal Fed rate will likely be higher.

Weakening data is good news for the Fed 

The US home prices have weakened the most since the 2007/2008 subprime crisis, and the weakness in home prices should have an easing effect on inflation numbers.

The US yield curve remains inverted, and the spread between the US 3-month and 10-year yield continues widening, hinting that an upcoming recession in the US could further help easing inflationary pressures.

Beyond the US, the global yield curve also prints the first inversion since at least 2000, which also hints at recession, and eventually weaker global inflation.

Finally, the latest consumer confidence data in the US shows further weakness, though it just weakened by around 2 points to 100.2 in November, and a number above 90 is generally considered as healthy.

Bad news is the US 1-year inflation expectations advanced to 7.2% in November from 6.9% printed a month earlier – warning that inflation will certainly not be on a steady downward path; there will be bumps along the way. 

A deluge of economic data

Besides Powell’s speech, investors will be watching the update on US GDP, expected to be revised slightly higher, the US job openings, expected to remain above 10 million and hinting at a still solid job environment, and the November ADP report, expected to reveal around 200’000 new private jobs added during last month.

On Thursday, the Fed’s favorite inflation gauge PCE data will show how much inflation eased in October.

Then on Friday, the NFP figures will reveal the strength of the US jobs market.

It’s a lot of data to process, but the simple rule of thumb is, strong inflation data would fuel the hawkish Fed expectations and have a positive impact on the US yields and the dollar, and a negative impact on equities. 

Likewise, strong growth, income, spending and solid jobs data would also fuel the hawkish Fed expectations on idea that the US economy remains strong enough to withstand aggressive Fed tightening.

What we want is, soft growth – but not too soft because recession fears are also bad for the market mood.

And what we really, really want is soft spending and inflation data before all. 

But in all cases, it’s possible that we won’t see US equities extend gains by much, because both scenarios are not ideal. Strong economic data, like strong growth and strong jobs means that the Fed will continue its aggressive tightening and could aim for relatively higher terminal rates. That’s bad for stock valuations. And soft inflation figures and softening spending are good for the Fed expectations, but they will boost recession odds, which is obviously not good for the stock valuations either.

As a result, we have certainly hit a top in the latest S&P500 rally, and the 200-DMA, which stands around 4050 – which also coincides with the year-to-date descending channel top should mark the end of the latest bear rally, with the expectation of a further fall to potentially around the 3400 mark. I’m sorry. 

Surprise fall in EZ inflation? 

Good news is that both a softer Fed due to a potentially softening inflation, or soft economic data in the US, should be negative for the US dollar, and could finally help the dollar ease against major currencies, hence ease the strong-dollar-led-high-inflation in the rest of the world. 

German inflation slowed to 11.3% in November, according to the data released yesterday, from 11.6% printed a month earlier, while inflation in Spain unexpectedly fell below 7%.

Do we celebrate? Not just yet. The figures are still very much above the ECB’s 2% target, but it’s at least going in the right direction.

Due today, investors will have their eyes set on the Eurozone’s preliminary inflation data for November. Who knows, maybe we will see a figure below 10%, in which case, the EURUSD could make another attempt above the 200-DMA which stands near 1.0370.

But as I always say, the US data, and Jerome Powell will say the last word on the overall direction in currency markets. Strong US data, and hawkish Fed comments could immediately turn the winds in favour of a stronger dollar yet again.