tightening monetary policy

Risk takers are not out dancing on the Wall Street this week before the Federal Reserve (Fed) President Powell's semiannual congressional testimony scheduled for today and tomorrow. Equities are down, oil is down, sovereign bonds are up. And the rally in equities versus a selloff in sovereign bonds is a pattern that we have been seeing since the rebound following the mini banking crisis, and the correlation between stocks and sovereign bonds are reestablished, again, after last year's visit to the positive territory.   This – the return of negative equity-bond correlation - is what we expected to happen this year, but for the exact opposite reason. We were expecting the sovereign bonds to recover, as the US was supposed to be in recession by now, whereas the sovereign bonds were supposed to find buyers as a result of softening, and even reversing Fed policy. But none of it happened. Equities rallied, the Fed became more aggressive on tightening its monetary policy, and now the American housing market starts printing surprisingly positive data, with housing starts and building permits flashing strong figures for May, defying the rising mortgage rates in the US due to the rising Fed rates. I mean housing starts jumped more than 20% in May, but loans for residential real estate slumped. We no longer know what to do with this data, and that's a cause for concern per se... not understanding the data.     What we know and understand very well, however, is, a strong housing market and tight jobs market will encourage Fed to hike more, and encourage other central banks to do more, as well. But not everyone is as lucky as Powell, because in Britain, the skyrocketing mortgage rates are turning into a serious headache that no one can solve for now. The UK home-loan approvals have been dropping after a post-pandemic peak, the refinancing costs took a lift, and political dispute is gaining momentum with Liberal Democrats asking for a £3 billion mortgage protection package to help people keep their homes, and their mortgages, while Jeremy Hunt says there is no money in the coffers for such fiscal support. The 2-year gilt yield slid below 5% yesterday, as a result of a broad-based flight to safer sovereign bonds, but the relief will likely remain short-lived and the outlook for Gilt market will likely remain negative with further, and significant rate hikes seen on the BoE's horizon.   Released this morning, the British inflation was expected to ease from 8.7% to 8.4% but did not ease... while core inflation unexpectedly jumped past the 7% mark again. These numbers warn that inflationary pressures in the UK are not under control and call for further rate hikes which will further squeeze the British households, without a guarantee of easing inflation. We will see what the BoE will do and say tomorrow, but we know that they now have a few doubts regarding the reliability of their inflation model which was pointing at a steep fall in H2 this year – a scenario that is unlikely to happen.   Cable jumped past the 1.28 mark following the inflation data, then rapidly fell back to the pre-data levels. The short-term direction will depend on a broad US dollar appetite, yet the medium-term outlook for the pound-dollar remains positive on the back of more hawkish BoE expectations, compared to the Fed's, and an advance toward the 1.30 is well possible, especially if the dollar appetite remains soft.     In the US, profit taking and flight to safety before Powell's testimony sent the S&P500 and Nasdaq stocks lower yesterday. The S&P500 slipped below the 4400 mark, while Nasdaq 100 tipped a toe below the 15000 mark but closed above this level.    The US dollar index traded higher for the 3rd session and is now testing the 50-DMA to the upside, while gold pushed below the 100-DMA as rising US yields and stronger dollar weigh on appetite for non-interest-bearing gold.    Yet, any hawkishness from Powell's testimony will likely be tempered by counter-expectation that the Fed may be going too fast too far, and could stop hiking before materializing the two rate hikes they revealed last week in their dot plot. It's true that the surprising data on housing and jobs front don't give a respite to the Fed, but a part of it is still believed to be the post-pandemic effect. For housing for example, insufficient number of homes due to the rising WFH demand, the retreat in material costs that exploded during the pandemic and the fading supply chain pressures help to explain why the market is not responding to the skyrocketing mortgage rates.   But the risk is there – it's not even hidden, and the meltdowns tend to happen without telling.   I mean, no one could tell that the US regional banks would go bankrupt a week before they did! Anyway, the risks are there, but the resilient eco data hints that Jerome Powell will confidently remain hawkish, and that could lead to some further downside correction in US big stocks which are now in overbought market. 

Recent PMI readings in the European economy have raised concerns about the future of the region. The Euro area composite PMI dipped below the 50-point mark, indicating a contraction for the first time this year. This significant shift in momentum suggests a potential 3 to 6-month period of economic decline.  The tightening monetary policy by the European Central Bank (ECB) aimed at reducing inflation has contributed to these contracting indicators. The drop in composite PMI was driven by a decline in both manufacturing and services PMI, with manufacturing consistently below the expansion territory. However, services PMI still remains in expansion, although a continued decrease could indicate contracting business confidence. Job creation in the Euro area remained limited to the services sector, while employment in factories declined for the first time in over two years. This slowdown in hiring, coupled with a decrease in business confidence, may lead to rising unemployment rates. On a positive note, the weakness in PMI readings can be partly attributed to destocking activities, which can benefit businesses in the long run. Additionally, there have been slight improvements in new order numbers, particularly in Italy's construction sector, suggesting a potential turnaround. These dynamics will likely influence the ECB's monetary stance moving forward.   FXMAG.COM:  How would you comment on the entire series of PMI readings from the European economy? What do the sentiment in industry and services say about the future of the European economy?   Santa Zvaigzne-Sproge, CFA: The Euro area composite PMI came out below the 50-point level indicating that it has entered the zone of contraction for the first time this year. This was a considerable change in momentum in comparison to April’s reading of 54.1 and even the previous month’s reading of 52.8. Furthermore, the historical data show us that once the PMI slides below the 50-point mark, it tends to stay there for a 3 to 6-month period. As tightening monetary policy by the ECB has been performed with the key aim to draw down inflation by reducing economic activity, contracting economic indicators such as PMI may not be a big surprise.    The drop in composite PMI resulted from a combination of lowering manufacturing PMI and services PMI data. However, the difference between both is nearly 10 points with services PMI still being in the expansion territory while manufacturing has not been there since August 2022. The large difference might be partially explained by the nature of both sectors. Manufacturing generally implies more capital intensity and longer production times, therefore, requiring more planning ahead, while services may be more flexible and adapt faster. However, if the services PMI data continues to lower, it may indicate that business confidence is contracting also in this sector.    In June, private companies in the Euro area maintained their efforts to expand their workforce, but job creation was limited to the services sector, while employment in factories declined for the first time since January 2021. The slowdown in hiring coincided with a decrease in business confidence across the Euro area. While firms maintained an optimistic outlook, the level of positive sentiment reached its lowest point in 2023 thus far. Growth expectations also softened in both the manufacturing and services sectors. In case job growth continues to stagnate, it may translate into increasing unemployment rates across the Euro area, which may give the ECB a reason to reconsider its hawkish monetary stance.    To finish on a more positive note, we need to point out that the weakness in PMI readings has been partially associated with destocking, leading to lower new order numbers. While negatively affecting PMI numbers, destocking may be considered as cyclical activity performed by managers beneficial to their businesses. Furthermore, destocking cannot last endlessly – once the stock levels reach a certain point, new orders may need to go up to support the “restocking”. There has been a somewhat positive development in this section in Italy where according to the latest construction PMI report, new orders increased marginally ending the six-month-long strike of contraction.  Santa Zvaigzne-Sproge, CFA, Head of Investment Advice Department at Conotoxia Ltd. (Conotoxia investment service) Materials, analysis, and opinions contained, referenced, or provided herein are intended solely for informational and educational purposes. The personal opinion of the author does not represent and should not be constructed as a statement, or investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73,02% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

The EUR/USD pair has been caught in turbulence amid conflicting fundamental signals, causing the price to move sideways. Market participants still need to unravel this tangle of contradictions to determine the price's direction. Currently, traders are driven by emotions, experiencing a rollercoaster-like ride. The verdict of the Federal Reserve and the US GDP The results of the Federal Reserve's July meeting were not in favor of the greenback. Bulls returned to the 1.1150 resistance level (the Tenkan-sen line on the 1D chart) and tested it. However, when it comes to the overall outcome, it would be more accurate to say otherwise: the market interpreted the results of the July meeting against the US currency, while the Fed's verdict can be viewed from different angles. The US central bank avoided specifics, especially regarding the future prospects of tightening monetary policy. According to Fed Chair Jerome Powell, everything will depend on what new economic data shows: the September meeting may end with either a rate hike or keeping rates unchanged. Such rhetoric disappointed dollar bulls, as recent inflation reports came out in the "red," reflecting a slowdown in inflation in the US. It is logical to assume that if July's inflation follows the trajectory of June's, the September rate hike will be in question. These conclusions put significant pressure on the greenback – the US dollar index hit a weekly low, declining towards the 100 level. However, the situation changed drastically. Dollar bulls once again saw a "light at the end of the tunnel" thanks to the latest US GDP report. The data significantly surpassed forecasts.   According to preliminary calculations, US GDP increased by 2.4% in the second quarter, with a growth forecast of 1.8%. It is worth mentioning that the first quarter's result was recently revised upwards: the initial estimate showed a 1.3% growth in the US economy, while the final data showed a different result of 2.0%. The Bureau of Economic Analysis report (US Department of Commerce agency) indicates that this growth was driven by increased consumer spending, government and local government spending, growth in non-residential fixed investment, private investment in equipment, and federal government spending. Consumer spending, which accounts for two-thirds of the economy, increased by 1.6% in the second quarter, while government spending increased by 2.6%. EUR/USD sellers are back in action In addition to the GDP report, dollar bulls were also pleasantly surprised by another indicator.   Durable Goods Orders in the US increased 4.7% in June, compared to forecasts of 1.3%. This reading followed the 2.0% increase recorded in May. Orders for durable goods excluding transportation also rose by 0.6% last month. This component of the report also showed a positive outcome, as most experts expected a more modest growth of 0.1%.   As a result, hawkish expectations regarding the Fed's future actions have increased in the market. According to the CME FedWatch Tool, the probability of a 25 basis points rate hike in September is nearly 30%, whereas after the announcement of the July meeting's outcome, this probability fluctuated in the range of 19-20%. Such an information background contributed to the "revival" of the greenback.   The US dollar index fully recovered all lost positions, rising to the middle of the 101 level. Consequently, the EUR/USD pair plummeted and hit two-week price lows.       The European Central Bank also played its role in this. Following the July meeting, the ECB raised interest rates by 25 basis points but did not announce further steps in this direction.   Similar to the Fed, the ECB indicated that one additional rate hike from the central bank would now depend on key economic data, primarily inflation. According to ECB President Christine Lagarde, the central bank has "turned off the autopilot" – decisions on interest rates will be made from meeting to meeting and will be based on "inflation forecasts, economic and financial data, and the underlying inflation dynamics."   It is worth noting that after the previous meeting, Lagarde had directly announced the rate hike at the July meeting. Conclusions The latest US reports, as well as the outcomes of the ECB's July meeting, "redrew" the fundamental picture for the EUR/USD pair. There is one more important piece of the puzzle remaining: the core PCE index, which will be published at the start of the US session on Friday, July 28th. However, for another upward reversal, this indicator must deviate significantly from the forecasted value (naturally, in a downward direction), with experts predicting a declining trend to 4.2% (following the May increase to 4.6%).   From a technical perspective, you can consider short positions on the pair after sellers overcome the support level of 1.0950 (Tenkan-sen line on the weekly chart). In such a case, the next bearish target for EUR/USD would be at 1.0850 – the upper band of the Kumo cloud on the 1D chart.