What to trade when the Fed remains in cautious mode
The Federal Reserve meeting on Wednesday highlighted how the US central bank will act as a crutch for the US economy for at least the next 2 years. The majority of the FOMC do not expect to see rates rise from 0% until 2022, and Fed chairman Powell said that they would “at least” sustain their current rate of purchases of government debt, which currently stands at $4bn per day. The Fed maintained its dovish stance, and presumably feels that it is too early to consider withdrawing any support from the US economy in the current climate, even though the labour market created a surprise 2.5 million jobs last month.
The Fed shoulders the burden as Congress fight over future stimulus
It appears that the Fed’s reading of last week’s NFP report was very different from the jubilant greeting it received from financial markets, especially in Europe. However, while the surprise increase in US jobs is welcome, the Fed is more likely to be concentrating on the 19.5 million jobs that are still lost, and which could threaten US economic performance in the coming months. At the same time as the Fed is pledging to provide continued support to the US economy, fiscal stimulus could be harder to come by. Although the Treasury Secretary said that the US economy may require another round of stimulus cheques sent directly to the US people, especially those working in sectors of the economy that are getting hammered by the coronavirus pandemic, Republicans are cooling towards the idea. The prospect of a second round of direct stimulus, a genius idea from the US government when it was first initiated, could end up being a partisan hot potato, with the Democrats supporting it, and the Republicans blocking it at every turn. Thus, at this stage of the fight against coronavirus, the US economy can only rely on the Fed for support.
When good news is bad news for stock markets
The market reaction will be fully gauged on Thursday when European markets open. Prior to the Fed meeting, markets were fairly quiet. European indices were flat to slightly lower. After the meeting, US indices were mixed. The Dow Jones was down more than 1%, and the S&P 500 was down approx. 0.5%. The Nasdaq bucked the trend and rose 0.7%, and broke above the psychologically important 10,000 level, a fresh record high. This breakthrough for the Nasdaq looks like a technical move to us, as the Fed meeting is likely to only have a limited impact on financial markets. While it is a relief that the Fed will maintain its support for the US economy, it didn’t announce any new policy measures. While the Fed sounded committed to its unprecedented support for the US economy at this meeting, there could be some residual concern that if the US economic data continues to beat expectations and a recovery looks like it might occur sooner than first thought, then the Fed could change its mind and start to tighten policy sooner than is currently expected. This could be one reason why the financial market reaction has been limited. Going forward, if the US economy continues to outperform then we may see limited upside for US stocks, as investors begin to imagine a future that doesn’t include unprecedented amounts of Fed support and excess money sloshing around the global financial system.
A better than expected US economy and what this means for the future of Fed policy is an issue for stocks in the medium to longer term. In the short term, we believe that the following sectors will be most impacted, in a positive and negative way, from the latest Fed communication.
· Companies that rely on debt for capital:this includes energy firms. Although the oil price has been highly volatile in recent months, it has settled down and appears to be in recovery mode. Added to this, some of the world’s largest energy companies look cheap compared to other sectors, which may add to their appeal in the coming months. Cheap debt servicing costs could also benefit the bottom line for these companies.
· Banks:they should underperform in a low interest rate environment, and we would expect banks to come under downward pressure in the next couple of days as investors digest the prospect of US rates remaining at 0% for the next two years.
· Companies in trouble:Hertz is just one company that has seen its share price surge in the wake of its bankruptcy announcement last month. Its share price surged 800%, from a low of $0.40 on 26thMay. It has since given up more than 60% of these gains, however, if you bought at the low then the upside is still attractive. A low interest rate environment could make it easier for companies like Hertz that have been devastated by Covid-19, to survive. Added to this, sectors linked to air travel and tourism are likely to be prioritised for further government support from UK, US and European governments. This could lead to more upside for some of the most battered stocks that fell victim to Covid-19.
· The end of lockdown: retailers may seem like a risky bet at this stage of the coronavirus pandemic. However, the ending of lockdowns in the Western world, combined with the low cost of debt for both business owners and consumers could lead to a decent recovery in sales later in the year. Pent up demand could also drive a decent recovery in revenues for companies that rely on discretionary consumer spending such as clothing retailers, restaurants and other leisure activities.
· The dollar is on the backfoot:This is likely to remain a major theme in the FX market for some time. This could give some breathing room to the pound and the euro along with emerging market currencies, which could all experience a decent recovery over the summer months.