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Powell’s inflection point in rear-view mirror, as Fed gets set to meet

Jay Powell looks at US economic prospects

Yesterday’s European market session turned out to be a rather dull affair, with the FTSE 100 and DAX both drifting back on concerns over events in India acting as a drag on global recovery prospects.

US markets also experienced a day of drift with the tech sector underperforming the wider market on the back of some light profit taking, ahead of the release of the latest numbers from Microsoft and Alphabet last night, both of which crushed expectations on revenues and profits, raising expectations for Apple’s results later today.

The late afternoon weakness in the Nasdaq also helped pull the S&P 500 off another fresh record high just shy of 4,200, nonetheless stock markets globally continue to look resilient, with markets in Asia edging higher this morning, which in turn should see markets here in Europe also open in positive territory.

We also saw US bonds sell off, helping to push US 10-year yields back above the 1.6% level for the first time in a week, a move that appeared to be triggered by US consumer confidence in April which smashed expectations, jumping strongly to its highest level in over a year, at 121.70. At the beginning of the year this indicator was at 88.9, reflecting wider concern over rising infection rates and the twilight of the Trump presidency. Isn’t it amazing what a successful vaccination programme and two fiscal stimulus packages can do? This big improvement served to mark yet another example of a US data point beating expectations, which brings us neatly on to today’s US Federal Reserve rate meeting, and what Fed officials are likely to make of the continued improvement in the economic numbers.

The economic outlook now is starkly different from when the Fed last met in March, with their primary concern being to try and temper market optimism about a strong economic rebound, against rising expectations that the US central bank might start to look at tapering its bond purchase programme, or start to raise rates well before 2024, in the face of concerns about sharply rising inflationary pressures. With another set of stimulus payments about to hit the doormats of US consumers in the days following the March meeting, these were very natural concerns, and the big rise in March retail sales bore that out. A large rise in March's non-farm payrolls also showed that the US jobs market is in a much better place than was the case previously, so the economic picture has changed markedly since the FOMC last met.

In spite of all of this, the messaging from Fed officials between meetings has been fairly consistent, and while yields have gone as high as 1.77%, they have since slipped back on uncertainty as to whether this is as good as it gets, or whether long-term rates have come too far too fast since the beginning of the year. The belief that this is as good as it gets probably seems a little naïve right now and while the Fed will be pleased at how the economy is looking based on current data, we will probably still need to see another couple of decent payrolls reports, before we start to see the central bank starting to prepare the ground for a slight change in tone. Until then, Powell will be keen to temper any enthusiasm or foster any expectation of a change in stance, even if officials do alter their dot plot forecasts to signal a slightly earlier taper.

Fed chair Jay Powell may well have said that the US economy was at an “inflection point” last month, however given the strength of recent data there is a case for arguing the economy is already starting to reach escape velocity. While no-one is suggesting that the Fed needs to tighten now, at some point it will start to have to lean into a taper if upcoming data continues to surprise to the upside, otherwise markets will do it for them, and this probably helps explain why yields experienced a late surge yesterday.

EUR/USD – squeezed up to the 1.2120 area on Monday, matching trend line resistance from the January peaks at 1.2350. A breakthrough opens up the prospect of a move back to those peaks. While below the risk is for a drift back down to the 1.1980 area.

GBP/USD – the 1.4020 area remains a key barrier to a move back to the February peaks. We have support at the 1 3820 area, and below that at the 1.3760 area.

EUR/GBP – the 0.8730 area remains a key resistance level, a break of which opens up the 0.8820 level. While below 0.8730 the bias remains for a move back to the lows last week at 0.8630.

USD/JPY – trend line support from the January lows continues to keep a floor under the US dollar. This support comes in at the 107.80 level, with yesterday’s break above 108.30 now targeting a move back to the 109.30 level. Below 107.60 opens up the prospect of a move back to the 106.80 area.


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