The ending week turned out to be rich about events and important economic statistics that will have a long-term impact on financial markets.
First of all, I would like to highlight the final decision of the FRS on monetary policy, which has become a determining factor in the markets’ behavior, probably, at least in the nearest future. The decision on interest rates and the volume of assets repurchased for $ 120 billion a month did not come as a surprise. Everything was unchanged here.
What influenced investors’ mood so much, forcing them to start reconsidering their attitude to the prospects for monetary policy?
Of course, it is worth highlighting the regulator’s forecasts for economic growth rates (GDP), labor market dynamics and inflation for the next few years. The Fed assumed that GDP this year will contract by 3.7% against the previous June forecast of -6.5%, in 2021 it will be 4.0% against 5.0%, in 2022 3.0% against 3.5%, and in 2023 2.5% against 1.9%.
This year Unemployment will reach a level of 7.6% against the previous forecast of 9.3%, 5.5% in 2021 against 6.5%, 4.6% in 2022 against 5.5% and 4.0% in 2023 against 4.1%. According to the regulator, inflation on personal consumption expenditures should amount to 1.2% this year against 0.8% according to the June forecast, 1.7% in 2021 against 1.6%, 1.8% in 2022 against 1.7% and 2.0% in 2023 against 2.0%.
It is difficult to say what the markets were really expecting. It seems that the more optimistic economic outlook came as a surprise to them, which led to sales in stock markets and an appreciation of the US dollar. In our opinion, the reason for this behavior was the growing expectation that the recovery of inflation against the background of its targeting and all other related measures could lead to an earlier start of the cycle of raising interest rates.
I suppose, according to Jerome Powell, this should not be expected until the end of 2023. In that case, the implementation of the Central Bank’s optimistic forecast against the background of a sharp rise in inflationary pressure will cause an increase in rates, if not next year, then in 2022 for sure.
We believe that an important outcome of the meeting was the desire of many large investors to revise the state of their investment portfolios. Earlier, they preferred buying shares of companies successfully operating in a tough pandemic, and these are mainly securities of companies from the NASDAQ index but with a change in strategic outlook, taking into account, possibly, faster recovery of the US economy, will force them to rebalance portfolios with the priority of company shares industrial, banking, commodities and other sectors that have been under the most substantial pressure in the context of the impact of COVID-19.
The likelihood of such a scenario will be a supporting factor for the dollar. If it does not grow steadily soon, it is unlikely to fall significantly.
Everything that I have described is, most likely, a scenario for the next week. While investors, in addition to the Fed factor, took into account this week the publication of disappointing economic statistics, which also contributed to the dynamics of the market. According to the data presented, industrial production in the US in August fell sharply to 0.4% from 3.5% and retail sales were not encouraging either, having risen only 0.6% last month against 0.9% a month earlier.
Thoughts and conclusions
Summing up the week, I want to note that the radical change in investor sentiment on the markets is possible. It may lead to to a continuation of the correction in the American stock market, primarily in the securities of companies in the technology sector, and the consolidation of the dollar against major currencies, if those economic data getting published next week will not start to play around with its positive values.