Inflation and increasing talk of a Fed taper could end the bull market run

Fed's action plan continues to remain the biggest unknown for markets

The Wall Street Bull in Manhattan. Volatility could return to US markets early next month in the lead up to the Federal Reserve's meeting on November 2 and 3. Reuters
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The US earnings season is in full flow and the optimism in equities is set to continue, with the S&P 500 Index trading just 2 per cent below its record high despite worrying signs about Chinese growth and stronger crude prices.

Ten-year Treasury yields also crossed 1.6 per cent, which suggests that bond markets are expecting a taper announcement by the US Federal Reserve as early as November. Despite this, the US dollar is finding stiff resistance at 94.50, where it has been trading lower since.

Third-quarter earnings opened with a bang this month and several big US banks announced stronger-than-expected gains during the period.

Five of the largest US banks – Morgan Stanley, Bank of America, Wells Fargo, Citigroup and JP Morgan Chase – all trumped their quarterly earnings expectations, reporting solid profits amid the continuing economic recovery from the Covid-19 pandemic despite rising inflation fears.

Meanwhile, the Dow Jones Index and the S&P 500 roared back to life after a sluggish September. Having pared their losses from last month, the S&P 500 is now 2 per cent off its record high and the Dow is sitting 1 per cent below its high.

The optimism for third-quarter earnings is expected to continue, with several large blue chips in the financial, technology and consumer goods segments reporting this week.

At the time of writing, Johnson & Johnson and Netflix were set to report their results on Tuesday afternoon US time, while technology heavyweights Tesla, ASML and IBM will follow suit on Wednesday.

I will be watching ASML closely – a stock I have written about previously. The Netherlands-based ASML, which manufactures complex lithography systems critical to the production of microchips, has a monopoly in the sector and is up 55 per cent this year.

ASML's recent move to sub-800 levels may provide an entry opportunity for those looking to pick up more technology exposure.

Consistent inflation threats and increasing murmurs of a Fed taper announcement as early as November could halt this year's bullish run
Gaurav Kashyap, head of futures at EGM Futures

PayPal and Intel will announce their results on Thursday before the action picks up again next week, with heavyweights Facebook, Google, Amazon, Microsoft and Apple all set to report.

The coming weeks could establish a new trend for US equities. On the one hand, consistent inflation threats and increasing murmurs of a Fed taper announcement as early as November could halt this year's bullish run.

However, if these stronger earnings continue with the technology heavyweights beating expectations, this optimism would surely carry through to the end of the year.

The coming Fed action continues to remain the biggest unknown for markets while the recent run of uneven data does not help.

Last month’s US non-farm payrolls report was a big disappointment, garnering an increase of only 194,000 new jobs, well below the expected reading of 500,000.

Meanwhile, the next US third-quarter gross domestic product report, which is due out on October 28, is expected to show quarter-on-quarter growth of 3.2 per cent, down from a reading of 6.7 per cent in the second quarter.

Despite these factors, US 10-year Treasury yields crept back above 1.6 per cent – the highest since June – which would suggest bond markets are starting to more aggressively price in a taper next month.

All things considered, I expect the upwards momentum to continue in US equity markets for the remainder of October, with major volatility set to return early next month in the lead up to the Fed meeting on November 2 and 3.

Finally, data from China earlier this week showed that economic growth had slowed to 4.9 per cent from an expected 5.2 per cent, led largely by drags in the industrial and property sectors.

Contagion risk from the Evergrande fallout continues to plague investor sentiment in China and all eyes will be on the People’s Bank of China and what measures it may enact to loosen monetary policy. A cut to the reserve ratio requirement – the minimum amount prescribed by the central bank that a commercial bank must hold in liquid assets – is the most likely outcome.

Gold continues to consolidate in the mid-$1,700s on the Dubai Gold & Commodities Exchange (DGCX). Expect the precious metal to find support at $1,730 levels with resistance coming in at $1,790 levels. These ranges should hold until we have more clarity from the Fed in early November.

The star of the commodity segment continues to be crude oil, which was trading at seven-year highs on the DGCX this week.

The easing of supply bottlenecks and demand from global economies reopening continues to have a positive effect on fuel consumption, while a report last week by Opec and the International Energy Agency confirmed global supply shortages have kept crude bulls interested.

Gaurav Kashyap is head of futures at EGM Futures. The views and opinions expressed in this article are those of the author and do not reflect the views of EGM Futures

Updated: October 20, 2021, 4:38 AM