Can the “bear market rally" continue, and will the Bank of England make history this week?

US stock markets had a stellar end to last week, rounding off an impressive monthly performance. The S&P 500 has closed July up nearly 13%, the best performance since November 2020, when a vaccine to target Covid 19 was announced. This recent rally was in part driven by better-than-expected earnings reports for Q2, with some record-breaking numbers for the US oil majors, and better than expected forward guidance for some of the tech giants. Amazon reported better than expected earnings for its cloud computing business, and closed Friday up more than 10%, for the month it has gained nearly 30%. There are two interesting aspects of the Q2 earnings season so far: 1, that analysts have tended to be more pessimistic, and earnings have beaten expectations, and 2, some of the big tech names including Apple and Amazon, have said that they aren’t seeing any macro/ inflation impact on spending. This could be a bullish dynamic for the foreseeable future.

The July rally in markets has been attributed to many things, including blue-chip earnings reports clearing a low bar, and the potential for the Fed to switch course and reverse recent rate rises, including last week’s second consecutive 75bp rate rise, after a spate of bad economic data. The US economy is technically in a recession, the housing market is showing broad signs of weakness and US consumer confidence is at a record low. The Fed has already scrapped forward guidance and has said that future rate decisions will be dependent on the future path for economic data. Thus, with the data coming in weaker than expected, the Citi Group US Economic Surprise Index is at its lowest level since the peak of the pandemic in 2020, one can reasonably assume that the Fed’s reliance on future economic data to make decisions is an excuse for its next move to be dovish? We are not so sure. Firstly, the Atlanta Fed President Bostic has said that he does not think that the US economy is in a recession (two quarters of negative economic growth is merely the technical definition of a recession). Likewise, even though consumer confidence is in the gutter, why are people still buying Apple’s iPhones, and spending money with Amazon? The iPhone news puzzles us, since if iPhone growth remains strong, then it should support consumption going forward since iPhone’s are so central to global commerce these days.

Overall, the picture remains difficult to read, and it is still not clear if the West’s economies are really struggling yet – even with multi-decade high levels of inflation. The countries that are doing the worst are those with high levels of USD-denominated debt and those tackling record high inflation – read Turkey. However, there are some sceptics out there who still believe that this is a bear market rally, albeit a very strong one, and they question the sustainability of the recent bounce. Firstly, inflation risks remain to the upside due to ongoing energy supply issues, and this could crimp growth further in the coming months. Secondly, the Fed’s “pivot” away from forward guidance may not be as dovish as some expect, particularly if the recent spate of positive US earnings surprises helps to boost consumer confidence.

Thus, while we don’t want to miss out on the stock market bottom, we continue to dip our toes in lightly until there becomes some concrete evidence about what markets will do next. This will be a big week with more than 160 companies reporting Q2 earnings on the S&P 500, BP and HSBC reporting in the UK, and a US labour market report at the end of the week. The labour market report is worth watching closely, to see if the labour market is finally starting to turn a corner to the downside. Strength in the labour market, including a 3.6% unemployment rate and decent payroll growth in recent months, is one reason why the Fed has been raising interest rates this year. We will talk about the payroll report in more detail later this week, however, we are watching the recent rise in jobless claims, which are back above 250k, after reaching a 50-year low of 167k in April. Overall, this is a big report, even if the headline numbers matter less than wage figures, with wage growth expected to remain well below the level of inflation at approx. 5% last month.

The BOE meeting is also worth watching, as more people in the market expect a 50bp hike, in line with the ECB and RBA, albeit lower than the Fed. If the BOE does hike by 50 bps, it would be the largest single rate hike since the BOE has been independent. It is worth noting that, on balance, economists still only expect a 25bp rate hike from the BOE, but it is a close call this month. BOE Governor, Andrew Bailey has said that a 50bp hike remains on the table, however, the trouble for traders is that the BOE has generally leaned dovish during this hiking cycle, compared to most of its peers. Added to this, the BOE was the first major central bank to hike rates and it has failed to stop inflation in its tracks. To make matters worse, inflation is expected to surge past double figures later this year when the energy price cap rises once again. The BOE will also reveal its long-term growth and inflation forecasts this week, which is expected to see inflation above 10%, 5 times the BOE’s target rate, and for growth to slump, economists expect the BOE to predict that UK growth will expand by 3.4% this year and a mere 0.6% next year.

Overall, pity the BOE since the UK’s economic outlook is so bleak. If the BOE’s growth forecast is revised down by more than expected, and if the BOE’s long term inflation forecast is expected to fall below the Bank’s 2% target, then it could weigh on GBP in the short term. However, a hawkish surprise from the BOE could boost GBP/USD, which has recently been grinding higher on the back of breaking technical resistance at 1.2075. This pair still needs to clear the $1.2210 hurdle, the 50-day moving average, to keep momentum to the upside. However, technical signals suggest that the tide is turning in favour of GBP, at least in the short term.