Dovish messaging from the FOMC supports risk taking

MARKETS

US equities were stronger Friday, S&P up 1.4% to 4.3% over the week. US10yr yields were down 3bps Friday to 2.65%, down 10bps for the week. Oil up 2.1%.

Dovish messaging from the FOMC and better than feared corporate earnings have supported equities.

At best, earnings beats have been average, but the lack of fireworks means boring is beautiful.

Still, investors have been diving back into growth stocks with a rapidly slowing economy hinting at less aggressive tightening. And with the market in the bad data is good mode, there has been little good economic news to reverse the path of least resistance. Put another way, monetary policy is no longer on a pre-determined course and will be data-dependent.

So with slowdown fears dominating and the deceleration in market-implied inflation trends looking increasingly optimistic, investors were broadening their risk-taking appetites.

But investors may pause from chasing the current trend, stock higher, and yields lower, ahead of the ISM and nonfarm payroll data this week. However, reasons are also solid for the Fed continuing on a less aggressive path with core inflation slowing two months in a row, and there are few signs of a wage-price spiral in the country.

Still, CPI releases will become even more critical. Slow-to-decline CPI inflation would suggest market pricing is not aggressive enough. With an increasingly data-dependent Fed, the volatility of central bank decisions increases, requiring a higher risk premium.

Moreover, history suggests inflationary cycles do not end abruptly. Persistent inflation that forces Fed tightening into restrictive territory points to further significant downside in duration-sensitive assets on a 3-6m horizon.

For now, though, lower US real yields are positive for duration-sensitive equities, gold and crypto and a headwind for the USD.

OIL

Energy traders have little in the way of new oil newsflows to whet their appetite; hence, they have moved on to the OPEC+ meeting on 3 August. Still, oil traded higher on dimming expectations that the producer group will imminently boost supply. But uncertainty around the meeting and an uptick in headline and event risk premium could keep oil traders on their toes to start the week.

From our vantage point, however, the OPEC + meeting doesn’t seem likely to rock the boat and be a significant oil price catalyst.

The broader focus remains on risks to demand from recessionary fears, which looks increasingly probable.

The US has expressed optimism about the potential for an OPEC+ supply response. However, it seems highly unlikely there will be much appetite for a significant increase in production, with Brent still ~15% down from year-to-data highs and -12% in the last month. OPEC+ seems more likely to signal a willingness to continue cooperating long-term, but it would be a surprise if the upcoming meeting resulted in a significant policy shift.

FOREX

With softer US rates driving flows, USD has been on the back foot. Expectations coalescing around a rapidly slowing economy hint at less aggressive tightening, markets priced out the more jumbo Fed hike scenario, and the pullback in US yields led to the unwinding of well-owned long USD positioning. With risk sentiment staying firm, the risk beta cast of characters is trading more upbeat.