Are markets too reliant on a dovish Fed?
European equities are a sea of green as we start a new week, buoyed by news that the Deutsche Bank and Commerzbank merger can go ahead. This has boosted the German Dax, however, the bigger theme driving European and global stocks today is the Federal Reserve. The US central bank meets later this week and the market continues to price in a dovish outcome from the meeting, which is giving equity bulls a welcome boost.
What to expect from the Fed meeting
Currently there is a near 99% chance that the Federal Reserve will hold rates steady between 2.25% and 2.5%; the interest rate decision is the least interesting aspect of this meeting. Instead, the market is waiting to hear what Fed chair Powell says during his press conference on Wednesday at 2pm EST/ 1900 GMT. The market is expecting him to say that the Fed’s balance sheet contraction programme – where the Fed sells back some of the $4.5 trillion worth of loans on its balance sheet, thus taking money out of the economy - will take a pause. The pace of the contraction in the Fed’s balance sheet was one reason why the markets had their wobble at the end of last year. Since then the Fed has been more mindful of twitchy markets and switched to a more neutral/ dovish rhetoric, which has helped markets to recover since the start of the year. The question for traders at this point is: can the Fed say to trigger another leg higher for global stocks?
What next for the S&P 500?
The S&P 500 is at a critical juncture, it is at its highest level since October, reversing all of the November/ December losses. 2,830 – a key resistance zone - has attracted some tentative selling interest as we head into this meeting. Whether or not the market can push above this level may depend on a very dovish outcome from the Fed, and an indefinite pause on its balance sheet reduction programme.
At Minerva Analysis, we believe that the Fed will deliver a dovish message to the market, however, we struggle to see how the Fed alone can extend the recent rally in stocks. Thus, we may see the market buy the rumour before selling the fact. After all, CME Fedwatch is already pricing in for a long term pause in the Fed’s rate-hiking cycle, and the market is expecting a pause in the balance sheet reduction programme, thus we do not believe that Jerome Powell et al can deliver anything new, and while his dovish tone may give the market one last hurrah, it won’t be enough to spur stocks higher. To clarify, we don’t expect a crash in stocks, however, we could see a small pullback by the end of the week, as the market reassesses the dovish commitment of the Fed and also worries about headwinds coming from slowing global growth, such as the third monthly fall in Japanese exports in February.
Pound bulls: beware the EU summit
In the FX market, the dollar is floundering today, after an early attempt at recovery was aborted around the 96.50 mark. As the market continues to price in a dovish Fed, we believe that the dollar will suffer as we lead up to Wednesday’s meeting, however, it may recover later in the week if the Fed is not as dovish as expected.
The pound is also under pressure, after a strong performance last week. Confusion and uncertainty around Brexit remain the order of the day. It was a fairly quiet weekend news-wise, a third vote on Theresa May’s Brexit deal is likely to be postponed until after the EU leaders’ summit on 21stMarch. This meeting is the real crunch point for Brexit in our view, and two outcomes are possible at this stage: 1, a revised deal is agreed, however, this would still need to be agreed by the British parliament before the 29thMarch deadline, or 2, the EU leaders agree to a 2-month extension of Brexit. The buoyant pound at the end of last week acted like the extension is already in place, however, it has yet to be agreed by the EU leaders. This is why we see this EU leaders’ summit as the last chance saloon for Brexit, we either get a deal or an extension, if neither of these things can be agreed then we leave without a deal on 29thMarch. This would be bad news for sterling bulls. Expect GBP volatility top rise as we move into the end of the week, however the FTSE 100 may benefit from GBP weakness.
What to watch
The Fed and the EU summit are dominating the agenda this week, however, watch out for the BOE meeting and further signs of slowing global growth, which could knock stock investors’ confidence.