May 14, 2020

Equity Markets Set To Drop More

Equity Markets Set To Drop More

The US futures are trading lower today as the Federal Reserve’s chairman has failed to assure the markets that they really have the tools to prop the recovery. The fact is that recovery has become a painful word, and it is going to take some time for the US and the global economy to get back to a healthy state.

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Jerome Powell, the Fed chairman, tried his best yesterday to assure the markets of two things . Firstly, that the Fed’s support for the markets is unwavering, and that they will continue to do whatever it takes to support the economy. The fact that he believes that the labor market may bottom out next month was a positive sign, and this helped the risk sentiment to some extent yesterday.

The US markets moved off their lows of the day towards the end of the US session. However, the recovery may not be as fast as previously thought. Such was also the view of Jerome Powell, and this has dented the risk appetite among investors today. 

Finally, the Fed isn’t ready to look at the possibility of negative interest rates yet. Some members believe that negative interest rates could help their policy, but Mr. Powell  seemed too confident that other tools can fight the abysmal economic readings. Again, we didn’t get any clarity with respect to what those tools are.

Perhaps, if the Fed provides some hint about the “other tools,” then the market can assess the effectiveness of those tools. This is because negative rates aren’t the most effective form of monetary policy, and the evidence for this can be seen in Japan and the Eurozone.

It is a trap, and once you are in that territory, it becomes arduous to come out of it. Nonetheless, if you look at the Treasury curve and dollar bets, it appears traders have already started to position themselves in favor of negative rates.

In the commodity space, the precious metal moved higher yesterday on the back of Jerome Powell’s comment. Gold trading price is back above the 1,700 mark, which is an encouraging sign for the bulls, but it has given up some of its gains due to the strength in the dollar index. The fact remains that traders have started the chatter of negative rates, and as long as this speculative argument remains, the possibility of gold prices touching the 2000 mark remains realistic. However, if the Fed kills this argument because the economic recovery starts to take better shape than anticipated, and there is less talk regarding Coronavirus because of effective medicine and vaccine, then we could be looking at a very different scenario altogether.

On the oil front, there is no doubt that we have seen some stellar rally for the current contracts for both Brent and Crude, but the long-term outlook hasn’t  changed much. The demand equation is still lackluster. However, on the supply side, we definitely have more positive factors that are likely to end the backwardness of the oil curve. The spread has started to narrow between the current contract and future contracts. Having said this, it is still difficult to think of a scenario that can lead the oil price beyond the $30 mark by the end of this year. I think the new resistance for the oil price is $30 to $35, and the prices may not reach the $40 mark any time soon.

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