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Macro update 1.8.22

Following on from last week’s second consecutive negative US GDP print and the Fed meeting, the focus on economic data is set to rise this week with ISM/PMI numbers and labour-market data (including June job openings on Tuesday and July NFPs and unemployment Friday).

Key points from the July Fed meeting and the press conference include:

  • The FOMC believe the 75bps hike to 2.25–2.5% puts the Fed funds rate at a neutral level;
  • The best estimate for a “moderately restrictive” rate is 3–3.5%, which per the June economic projections is expected to be reached by end-2022;
  • Forward guidance was dropped;
  • Restoring price stability remains the priority and a slowdown is necessary for this and
  • Current slowdown acknowledged, but labour market the key shoe that needs to fall for a pivot.

This puts more emphasis on economic data, rather than projections. It also suggests a more reactive Fed. We believe the bottom line is that weak (strong) economic data should be supportive (unsupportive) of risk assets since it implies a less (more) hawkish stance.

For the upside scenario, such a move is likely to be amplified by still-low positioning in risk assets like equities (see chart below). Hence, the current rally may have further to run.

Momentum, mo problems

The Fed’s message of restrictive policy and stating a slowdown was necessary to achieve its goals are seemingly being ignored by markets at present. Instead, the focus is on an expected less hawkish stance later this year. This may be enough to support risk assets during the typically illiquid summertime. However, strong data combined with Fed speakers reiterating the Bank’s hawkish stance may yet put the brakes on the current rally.

In addition, for all the chatter about Fed easing, the market is not currently expecting much in 2023. As the chart below shows, the Fed funds rate at end-2023 will be above the current level (i.e. still slightly restrictive). Again, this suggests support for risk assets would be limited amid tight financial conditions.

The level of the Fed funds rate may not matter for direction — it is the marginal change that is more important — but the level is still likely to act as a cap on gains especially relative ultra-loose conditions during the pandemic. Hence, it seems reasonable not to expect prices to revert anywhere close to all-time highs. For perspective the bear markets shown below indicate further downside from current levels.

Source: Bitcoin Magazine Pro

Meanwhile, significant deleveraging has taken place (see chart below), but is not yet at pre-pandemic levels. If risk aversion returns, this could push margin debt to levels below the 2020 nadir. This speaks to the potential for further downside for stock prices.

Fade the rally

Digital assets, like equities, rallied last week but conviction does not appear high. The rally in Bitcoin fell well short of technical levels and this may speak to ongoing macro and sector-specific risks that could come back to bite, making it likely that investors use rallies as an excuse to sell. One positive has been the continued neutral reaction to more crypto-specific bad news, once again indicating that much has been priced in. Again though, this confidence is fragile. Indeed, while recent focus has been on liquidations and bankruptcies, the SEC coming after crypto is another strong headwind as it leaves significant uncertainty. Once there is regulatory clarity, this should be a positive in that it will allow institutions to partake. In the interim though, “the force is strong with this one” so its likely prudent to be:

Kind regards

Lyndon Barreto, CFA

Chief Economist and Project Specialist

Disclaimer: The content above does not constitute investment or financial advice. All statements are opinion and not statements of fact.

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