James has provided his excellent fundamental analysis for the year-end and ahead this week.
There was a lot of data, releases and statements last week – I had planned to not place any trades due to the huge amount of uncertainty and I stuck to the plan. I have just looked at my charts for the first time since last weekend. Although I wasn’t looking at the price I was plugged into the news every day and was fully aware of the releases, read the statements, and followed the commentary to gauge the sentiment and prevailing thought. It was quite nice to build a mental picture of where I thought things were moving from a purely macro/fundamental viewpoint without looking at the charts.
Building the basics in macro/fundamental skill was one of a few things I wanted to focus on developing since the summer and I’m beginning to feel a bit more confident and pieces are starting to come together, but I’m still far from competent so please feel free to add anything to agree or disagree with.
The aim of this write up is to try and digest last week, but also try and create a picture that I’ll use going into next year. There are so many different variables and factors my view of next year will change, probably significantly, but if I can build a base case I can work from that. If and when I’m wrong I can take that as a lesson and understand why and improve my future workings. I want to do a bit of research and reading into things, so I will likely break up my views/opinions into different currencies and spread the work over a week or so.
But it could be like the Forth Bridge (probably a northern England/Scotland analogy) and by the time I’ve completed the last currency something will have changed and I’ll need to redo the first one again.
Also, ultimately, it’s not what I think that matters, it’s what the market and the collective mind is doing – my primary aim for my analysis is to help keep me out of bad trades – if it gets me into good ones that great, but limiting the downside via fundamentals and exploiting the upside using a combination of technicals and fundamentals is the ultimate aim.
Hiked by 50bps to bring the rate to 4.50% – this was not a shock and was the most likely outcome.
The dot plot for the year ahead [median] 5.25% with more upside appetite than downside appetite (7 vs 2). It is also interesting to note that the year end futures are also implying that the year-end rate will be 4.5%.
To achieve the Futures estimate with 8 meetings per year and the rate currently at 4.5%, the very early consensus is that the next hike will be 25bp and with 5% being the highest probability not until June 2023 this means the market is currently pricing in pause in hikes for maximum of 2 meetings then a cut. Based on what has been said by the Fed, I think there are quite big risks to this materialising.
From the statement (italics) with my take on it in normal font:
The Committee anticipates that ongoing increases in the target range will be appropriate – Ongoing increases suggest multiple hikes in the short term so we can expect hikes until at least the May meeting.
In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. – This suggests that a pause period to ensure the changes in rates have worked their way through the system. I would suggest that a minimum of a quarter’s worth of data would be required to change course. Assuming that peak rate of 5.25% is reached in June or July then a cut could happen in Nov or Dec – but to get in line with the futures implied rate, it would have to be a 75bps cut – which is unlikely given the amount of times Powell has said he doesn’t want to stop too soon or retreat too early. 75bps cut could see a double top in inflation.
The hawkishness of the Fed was reinforced towards the end of the week with Messer saying she sees rates higher than the median and the Fed will need to maintain rates for an extended period once hikes are done. Williams also hinted that rates could be higher if that’s what it takes.
I see the Fed rates as supporting the dollar over the next year, and if inflation doesn’t come down by much in the early part of the year, It could strengthen it.
Recession and economic projections:
The statement of economic projections pretty much painted a worse picture for the coming year than a few months ago. Unemployment seen as higher and GDP seen as lower – the forecasts are estimating 0.5% growth next year.
Higher unemployment, lower growth, higher cost of borrowing, less available capital and persistent inflation has the potential to drive the S&P a lot lower and into safe haven assets such as the dollar, CHF, JPY or gold.
Valuations in the S&P have been relentlessly increasing – If you saw the S&P(12m) chart without any context, could you tell it apart from the Bitcoin(1month) chart?
I get that it’s been driven by bigger forces and factors, but if you say bitcoin and a lot of cryptos were unsustainable, how is the debt that has driven the S&P growth Different?
On employment, something which Marc also mentioned in his last video was the ‘fudging’ of figures. https://www.zerohedge.com/markets/h…ed-admits-us-jobs-overstated-least-11-million This could play a big part in setting the direction of the Fed and brings a lot of uncertainty.
DXY: The DXY has broken out of the large range it has been in since January 2015. It played the range from 89 – 100/102. This clear break above these previous peaks coupled with the above factors, I can see a strong case for the dollar to remain strong compared to it’s peers – however there are some potential exceptions.
Risks to this view are if Inflation drops off a lot quicker than expected – looking at the makeup of inflation this could be done through a few different channels. Supply chains improve to pre-covid levels and China and other major exporters fully ramp up output. The removal of supply squeeze in commodities and energy due to the war in Ukraine. If this is resolved, this eases a lot of pressure and greatly increases the supply of a lot of things from fertiliser, wheat, cooking oils through to energy supplies to europe. This removes a great deal of risk too potentially seeing a slighter risk on appetite.