Continued Fed monetary easing and fiscal stimulus to sustain US stock rally

A short-term spike in inflation is priced in and should not hinder markets

A man passes the New York Stock Exchange. The Dow Jones Industrial Average is up 8.6 per cent since March 1, while the S&P 500 gained 7.4 per cent as it crossed 4,000. Photo: AP

US equity markets have been on an absolute tear through the end of March and the early part of April, pushing to all-time highs. The Dow Jones Industrial Average is up 8.6 per cent since March 1, while the S&P500 gained 7.4 per cent and crossed the key 4,000 level.

Market sentiment in equities is soaring, with more money pouring into stock-based funds over the past five months than the previous 12 years combined, according to a report by the Bank of America, .

Amid Covid-19 volatility and the influx of volume in GameStop and AMC stocks, some $569 billion has poured into equities compared with the $452bn over the previous 12 years.

Historic central bank liquidity measures have assisted the meteoric rise. Looking ahead, there is little to disrupt the upside moves.

Markets continue to monitor the US Federal Reserve and any signs of its hawkish rhetoric towards interest rates.

During an interview with CBS News' 60 Minutes programme last weekend, Fed chairman Jerome Powell reiterated that growth and employment will pick up in the quarters ahead. He also reassured markets that that the Fed will not change its existing zero per cent interest rate policy or its monthly $120bn bond purchase programme.

The continued monetary easing by the Fed, coupled with the US government's expansive fiscal measures announced last month, will have a direct impact on inflation rates.

We saw 10-year Treasury yields rise to 14-month highs at 1.776 per cent on March 30. With US inflationary data yet to be released at the time of writing, expect price pressure to continue to tick higher this month – 0.5 per cent is expected month-on-month and 2.5 per cent is expected year-on-year.

However, this should not impact investor sentiment. A short-term spike in inflation is largely priced in and should not impede stock markets.

I expect robust earnings, which will continue to see equity markets trend higher

One of the themes I have written about over the past couple of months is the performance of US Treasury yields and the upward momentum we have been noticing in the first quarter. Ten-year yields have come off those 14-month highs at the end of March, but are still comfortably holding above 1.6 per cent.

Demand during recent US government bond auctions is healthy and trending at 2021 averages. An auction on Monday showed that about $38bn worth of 10-year Treasuries were picked up out of a total of $90bn tendered, which at a bid-to-cover ratio of 2.36 has largely been in line with demand witnessed during monthly bond auctions.

Keep an eye on these government auctions in the months ahead. Growth in the bid-to-cover ratio suggests that capital is being routed from equity markets to the bond market.

Also coming up this week is the start of the US earnings season. Companies will announce first-quarter results, with JP Morgan, Wells Fargo and Goldman Sachs announcing on Wednesday, followed by Alcoa, Delta Airlines, Bank of America and Citigroup on Thursday. I don’t expect to see too many surprises and expect robust earnings, which will continue to see equity markets trend higher.

Looking at the currency markets, the US Dollar Index peaked at more than four-month highs on March 30 on the back of robust bond yields. However, with yields paring gains in early April, the index has slipped back towards 92 levels, which has resulted in EUR/USD trading back above 1.19 levels on the Dubai Gold and Commodities Exchange.

I expect the US dollar to continue trading in its current range. I am keeping those March lows of 91.4 as the next strong resistance level with upsides capped at 92.5 in April, while EUR/USD will try to test 1.20 levels this month. However, any move higher will not be sustainable.

DGCX’s gold contract this month touched $1,750 following drops in US yields and the dollar. Upward moves look weak in the precious metal. I expect to see a move towards the channel between $1,660 and $1,680 before building long positions.

While optimism remains high and risk on sentiments will help markets continue their upward moves, keep an eye on how US interest rates perform in the short term. Another move towards the 1.776 per cent high could hinder this current sentiment.

Gaurav Kashyap is a market strategist at Equiti Global Markets. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti