Three central banks hold meetings on three different continents this week, all with potential implications for markets in the months ahead. The U.S. Fed meeting ending Wednesday could draw plenty of headlines, but gatherings of the European Central Bank (ECB) and Bank of Japan (BOJ) might hold more possible intrigue and perhaps have greater impact over the long run.
Before the meetings begin a little later this week, the markets open Monday with investors digesting the acrimonious conclusion of the G-7 conference. Another potential focus is the meeting in Singapore starting Monday night (U.S. time) between President Trump and North Korean leader Kim Jong Un. By this time tomorrow, investors might have some idea whether Trump and Kim made any progress on the issue of North Korea’s nuclear weapons. If you remember, concerns about tension between the two countries helped send a chill through world markets late last year.
Early indications Monday pointed toward some potential pressure on U.S. stocks following gains overnight in Europe and most of Asia. Trading could be a little slow Monday and Tuesday ahead of the Fed decision.
Sense of Mystery Lacking with Fed
There’s not really much drama going into the Fed meeting, with futures prices pointing toward about a 91 percent chance of a rate hike (see more below). It’s probably less about what the Fed does than what Fed Chair Jerome Powell might say in his post-meeting press conference. Consider listening for any observations from him on future Fed policy, economic growth, and potential wage and price pressure.
The Europe and Japan meetings, however, aren’t necessarily as cut and dry. Many analysts, as well as the ECB’s chief economist, have signaled that the ECB might be ready to announce Thursday it’s going to end its bond purchases when the $35 billion a month program expires after September. If the ECB decides to do this, it could give the euro a boost and put pressure on the U.S. dollar with possible implications for U.S. corporate earnings. Remember, a weaker dollar often helps U.S. multinationals by making their products more affordable overseas. What happens overseas definitely can affect the U.S.
Looking the other direction, across the Pacific, the Japanese yen has become a place people often turn to in times of trouble, and if trade relations between the U.S. and its allies continue to erode we could potentially see some investors start rolling out of the dollar and into the yen hoping to find a point of safety. The yen was about flat last week, but economic problems percolating in countries like Brazil, Turkey, and South Africa also could potentially draw investors toward “safe havens” such as the yen or U.S. Treasuries.
The BOJ meeting concludes Friday with a policy statement, and analysts generally expect it to continue its easy money policy as inflation numbers in Japan continue to lag the BOJ’s targets.
Small-Caps On The March
The BOJ and ECB meetings this week could help put focus back on U.S. trade relations. If investors believe there’s risk overseas, it’s possible the Russell 2000 (RUT) index of small-cap U.S. stocks could benefit. The Russell is now used as a hedge by many people rather than going into fixed income. Some people see the Russell as more desirable than buying bonds because it can be used as a tool for foreign hedging, and that could be one reason the RUT has marched to new record highs in recent days.
The week also brings some key data. The latest U.S. inflation numbers stand out, with consumer prices for May due on Tuesday and producer prices on Wednesday. Judging by analyst estimates heading into the reports, no major inflation uptick is expected. Wall Street consensus is 0.3 percent for both CPI and PPI, and 0.2 percent for the closely watched core CPI and PPI, Briefing.com said. Keep in mind that neither CPI nor PPI in April showed much sign of price pressure, and if numbers come in as analysts expect, it could further ease investor worries. The other major economic report this week is retail sales, scheduled for Thursday.
Few Left Uninvited From Sector Party
Looking back at last week, all the major U.S. indices rose, and Nasdaq (COMP) and the RUT both scurried to new all-time highs. The Dow Jones Transportation Average, sometimes seen as an economic barometer, also climbed. Sector-wise, both growth and “defensive” parts of the market mostly finished higher, with telecoms, consumer discretionary, and consumer staples among the biggest gainers. Info tech rose, too, but ended well off the leading sector pace.
Another metric to consider watching this week is crude oil. The market finished about flat last week, but media reports that Saudi Arabia has begun raising production could help fuel perceptions that OPEC might be ready to ease its production cuts when it meets June 22. Crude prices fell 1 percent early Monday in part due to expectations for higher supplies. Lower oil prices sometimes can pressure the energy sector, but might put a wind at the back of transport stocks on hopes of falling input costs.
Figure 1: Barometer Rising: Copper (candlestick chart) and the Dow Jones Transportation Average (purple line) are often thought of as “barometers” that can shed light on the state of economic health. Historically, strength in both transports and copper often signals strength in the broader world economy. Both metrics rose over the last month. Data Sources: Dow Jones, CME Group. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results. Data Source: S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
Though gross domestic product (GDP) posted just 2.2 percent growth in Q1 (according to the government’s most recent estimate), there’s a sense that Q2 could provide brighter tidings. With just a few weeks left in the quarter, the Atlanta Fed’s GDP Now indicator projects 4.6 percent GDP growth. That new estimate, which came out Friday, was up from the previous 4.5 percent estimate due in part to an increase in inventory investment seen in Friday’s wholesale trade release from the U.S. Census Bureau. The GDP Now forecast is well above the median of analysts surveyed by CNBC, which is 3.7 percent. Even a 3.7 percent rise would be solid, and perhaps provide more evidence that recent firm economic data could actually be contributing to economic growth. It’s still a while until the government weighs in, however, with its first estimate for Q2 not scheduled until late next month.
With the post-recession bull market now among the lengthiest ever, there’s concern in some quarters about how much longer it might last. There’s no way to predict the future, but remember the old saying that bull markets don’t die of old age; they die of fear. At this point, U.S. economic data don’t seem to be scaring too many people, though geopolitics might be another story. Also, this particular bull market seems to have gotten a little boost from the recent U.S. tax reform legislation, which has generally helped companies by reducing their tax rates and allowing them to repatriate profits from overseas. Typically, you don’t see major tax reform at this stage of a bull market, so the question is whether that might help extend the rally further. Only time will tell.
About That Fourth Hike...
Judging from the futures market, a rate hike this week seems almost like a pre-ordained conclusion, though nothing is ever in stone. Fed funds futures placed the odds recently at 91.3 percent. However, the real debate remains one that isn’t likely to be resolved until much later this year, and that’s the question of whether the Fed decides to hike rates four times this year or just three. Futures prices now project about a 63 percent chance of a third hike by September, and an 83 percent chance of that by the end of the year. A fourth hike looks less certain and probably depends on a number of economic variables. At this point, chances appear a bit lower than they did earlier in the year, standing near 36 percent. It wasn’t too long ago that futures projected odds for a fourth hike at around 50-50, but perhaps the recent slide in German bond yields put a chill on that. There’s a sense the Fed might not want to get U.S. rates too far ahead of rates in other developed markets.
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