Trade Wars, Volatility, S&P 500, US Dollar Talking Points
- S&P 500 is dealing with 2018 déjà vu, commerce wars are brewing, haven demand is rising
- Meanwhile, US recession fears are climbing. Will the Fed step in and lower charges?
- US Dollar could possibly be able to learn both approach, DXY eyes May 2017 highs
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S&P 500 Faces Similar Scenario as in Late 2018, The Background
In the fourth quarter of 2018, the S&P 500 plummeted over 20% because it entered correction territory. Equities all over the world adopted, Japan’s and Germany’s benchmark Nikkei 225 and DAX 30 dropped respectively. Demand for protected havens provided a beneficiant enhance to the world’s most-liquid foreign money, the US Dollar. Local authorities bond costs rallied as merchants flocked into what is basically the world’s “risk-free” asset.
There was a lot to fret about for monetary markets, reminiscent of an escalation in US-China commerce wars, slowing international progress and the uncertainty over the way forward for Brexit. Meanwhile, the Federal Reserve unexpectedly raised charges 4 instances by year-end. The central financial institution was partially pushed to take action by the White House delivering on company tax cuts.
What finally result in a restoration within the S&P 500 was arguably the Fed’s dovish financial coverage shift, pictured under. It was evident by the start of 2019 that there was fading confidence from policymakers over the trajectory of rates of interest. One factor result in one other and the central financial institution went from envisioning two hikes this 12 months, to none in any respect.
For most of this 12 months, a comparatively timid Fed and cooling fears of a US-China commerce struggle helped the S&P 500 trim its losses from 2018. But this has since modified, and we could also be dealing with the same situation to what markets witnessed final 12 months. US-China commerce struggle fears have been revived as of late, however the Fed is stressing the significance of a data-dependent method.
S&P 500 Versus US 2-Year Government Bond Yields
Chart Created in TradingView
Rising Fears of a US Recession, Will the Fed Step in?
The S&P 500 finds itself falling alongside US front-end authorities bond yields once more. This is a traditional instance of threat aversion as merchants purchase into Treasuries, pushing costs increased on the expense of yields. Last time, it took the Fed pausing charge hikes to carry an finish to the panic, and markets are actually anticipating them to take it one step additional.
Fed funds futures are pricing in barely better-than-even odds that the central financial institution will lower in September, with probably extra to come back in 2020. This could also be for good cause. On the following chart under is the distinction between 10-year and 3-month bond yields. This key part of the US yield curve has inverted, which means that short-term yields are above longer-term options.
While that is sometimes seen as a warning signal of a recession, whereby charge cuts sooner or later assist help financial exercise, it often takes persistence on this sign to be assured in follow-through. Back in the summertime of 2006, the identical section of the yield curve inverted and stayed so for a few 12 months. US housing costs in the meantime decreased because the bubble burst, resulting in the 2008 monetary disaster.
US 10-Year and 3-Month Bond Yield Spread
Chart Created in TradingView
Demand for Havens Rise as Trade War Fears Brew
Recent exercise in US authorities bond auctions appears to indicate fading confidence in upbeat financial exercise forward. On May 28, we noticed an uptick in demand for bonds nearer in the direction of the entrance finish of the curve. This included 3-month, 6-month and 2-year Treasuries. However, demand for longer-dated paper – reminiscent of 5-year and 7-year notes – weakened
In brief, which means markets could possibly be anticipating that charges begin rising once more in about 5-7 years. But the query comes again to how the Fed will reply with dangers reminiscent of commerce wars, with a brand new one probably re-opening up on the North American entrance, and inserting the fledgling USMCA deal unsure. Worrying proliferation of CLOs compounds the danger of panic throughout monetary markets. Looking at May’s FOMC assembly minutes, we noticed the central financial institution downplay exterior developments whereas stressing the significance of incoming economics news-flow.
If the US economic system chugs alongside solidly, we might not get a charge lower and this may possible add gasoline to the selloff seen in equities, as this may in all probability disappoint the markets. The US Citi Economic Surprise Index continues to be unfavourable nonetheless, hinting that analysts are overestimating the well being and vigor of the economic system. If this holds true, softer-than-expected knowledge might compel the Fed to decrease charges because it pauses the unwinding of its steadiness sheet.
Impact on US Dollar
However, it’s unclear if this may essentially bode unwell for the US Dollar judging by how properly it carried out this 12 months regardless of a comparatively dovish Fed. If the central financial institution resorts to reducing charges on account of a downturn within the economic system, that will gasoline threat aversion, which bodes properly for havens such because the Greenback. As talked about earlier, a scarcity of follow-through on delivering cuts also can induce market pessimism. With that in thoughts, any near-term USD weak point could also be restricted.
How to Trade the USD Index
US Dollar Technical Analysis
From a technical standpoint, the DXY might discover itself finally taking out near-term resistance, which is a spread between 98.15 and 98.37. If these are cleared, that will open the door to testing highs final seen in May 2017 between 99.63 and 99.89. In the occasion of declines within the US Dollar nonetheless, regulate the rising pattern line from September 2018. It might maintain and preserve the dominant uptrend intact.
DXY Daily Chart
*Charts Created in TradingView
US Dollar Trading Resources
— Written by Daniel Dubrovsky, Junior Currency Analyst for DailyFX.com
To contact Daniel, use the feedback part under or @ddubrovskyFX on Twitter