After a rocky start, May ultimately closed another green month for equities and riskier assets. It was the fourth consecutive month of higher closings for the Dow Jones Industrial Average and the broader S&P 500 index. However, technology stocks continued to remain weak, with the Nasdaq down more than 1.5 per cent on the month.
On the currency markets, euro-dollar futures on the Dubai Gold and Commodities Exchange held strong above 1.22 levels, gaining 0.25 per cent. Meanwhile, pound-dollar futures were above 1.42 after hitting a three-year high of 1.4248 in early morning trading on Tuesday.
The US Dollar Index, a measure of the value of the greenback against a weighted basket of major currencies, toyed with 89.20 levels, the lowest reached in January this year. Across April and May, the dollar has shed more than 3 per cent in value.
Not much changed in markets over the second half of May; equities continued to pare losses experienced early on and US Federal Reserve “speak” has remained constant.
The inflationary theme, addressed in my last column, appears to have taken a back seat but it will surely re-emerge. Inflation data from last week – Core PCE, a price index defined as personal consumption expenditures less food and energy prices, which is the Fed's preferred method of measuring inflation – slightly beat expectations with a monthly reading of 0.7 per cent compared with 0.4 per cent in April.
The annual reading came in at 3.1 per cent, compared with a previous reading of 1.9 per cent.
The sharp increase in prices failed to yield a reaction from the markets, which have seemingly become used to a hawkish Fed that has committed to keeping rates lower and maintaining its current $120 billion monthly asset purchase plan.
While the Fed may have suggested that there could be a reduction in the pace of asset purchases, this is unlikely to happen for many months as it is happy to let price pressures trend higher because they are “transitory.”
Even gold, an asset class considered to be a traditional hedge against inflation, was buoyant after the release of the PCE data and was unaffected in its run past $1,900 this month – its highest level in three months.
The Fed reconvenes on June 15 and 16 and projection materials are set to be released. Expect volatility to pick up as markets look for clues on future Fed guidance.
The dot plot, a key metric in establishing positioning within the Fed, will be the most interesting marker. At the last projections meeting in March, four Fed officials predicted rate increases as early as 2022 and up to seven Fed members predicted rate increases in 2023. If we go further back to the projections meeting in December, only one Fed official expected a rate hike in 2022, while five saw a hike in 2023.
If the dot plots suggest additional Fed members are expecting higher rates, this will be market negative for stocks in the short term. Back in March, when the dot plot showed more hawkish positioning by the Fed, the S&P sold off about 2 per cent in the five days after the meeting.
Technology stocks were hit even harder, selling off 2.88 per cent in only one day of trading after the Federal Open Market Committee meeting.
Over the course of the past few months, equities went on to recover and I expect this kind of pricing action to continue. However, if there are no changes in the dot plot from March, expect an accelerated higher leg up in the US markets.
Across the pond, prospects for euro-dollar and pound-dollar futures continue to remain strong. We have the European Central Bank meeting on June 10 and it will be interesting if the ECB votes to reduce its current €80bn monthly bond buying programme.
The ultra-loose rhetoric from high-ranking ECB members has stalled the impressive euro-dollar bull run. A confirmation from the June 10 meeting that there will be no reduction in monthly asset purchases will hurt euro-dollar prospects in the short term.
Finally, pound-dollar futures may make a real run at those 1.4360 levels from April 2018 on the back of perhaps the most hawkish of all major central banks, the Bank of England.
Optimistic tones from key members last month, along with British Prime Minister Boris Johnson’s commitment that the country’s June 21 reopening will not be delayed, and their overall forecast for a faster recovery have all combined to help the pound gain the most against its peers, which is why I am keeping the 1.4360 level on my radar.
Gaurav Kashyap is head of futures at EGM Futures DMCC. The views and opinions expressed in this article are those of the author and do not reflect the views of EGM Futures DMCC
