An aggressive Fed and a fearful market

SZE HAN YEO

LAST week, the US Consumer Price Index (CPI) came in at 8.3 per cent year-on-year, higher than most street forecasts and an indication that the elevated levels of inflation will likely stick around longer. This is occurring amid a backdrop of a rapidly proliferating US labour market and has added to the reasons for the US Federal Reserve pursuing more aggressive tightening with regards to financial conditions.

Data released on May 3 has shown that the US unemployment rate for April remained unchanged in comparison to March, staying at a low of 3.6 per cent. Average hourly earnings have risen yet again and job openings were at a record high - signs that the demand for labour in the country has yet to cool off and that there is still pressure for businesses to further raise wages to hire.

The US central bank has a long-term inflation target of 2 per cent and is taking massive actions to rein in inflation to prevent an upward wage-price spiral.

Just two weeks ago, the Fed had raised its benchmark interest rate by 50 basis points from 0.25 per cent to 0.75 per cent, the biggest single-day hike in more than 20 years. It also announced that it will start reducing its balance sheet starting with trimmings of US$60 billion of Treasuries and US$35 billion of mortgage-backed securities per month from June 1.

Fed chair Jerome Powell commented that Fed officials are prepared to approve similar half-percentage point increases at each of the next two FOMC meetings in June and July, but will that stop there?

Some analysts think not and suggest that the US central bank may surprise the markets with a 50-basis-point hike in September as well, in an effort to stave off the biggest inflationary pressures befalling the US in decades.

While the central bank policies are aimed at curtailing demand for goods and services, many have argued that their actions may have limited effectiveness in bringing back price stability to pre-Covid-19 levels as the underlying factors responsible for the price surges today are supply-related.

The war in Ukraine and the tightening sanctions on Russian energy exports are adding to scarcity woes and inflating the prices of oil, gas and other commodities. In China, continued Covid-19 lockdowns and strict restrictions at major trade cities are causing cargoes to be held up at ports and processing centres, bringing about mayhem and disruptions to businesses and consumers down the supply chain both locally and abroad.

Bearishness to persist near-term

Since reaching a historical high of 4,818 on Jan 4, the S&P 500 (SPX) has been trending lower and at the time of writing, is down -16 per cent from its peak.

On Mar 14, the 50-Moving Average (MA) line had cut down and across the 200-MA line from the top, creating a Death Cross chart pattern that signalled a transition from a protracted bullish trend to a bearish one.

The Fibonacci indicators suggest that should the near-term support range of 3,850-3,900 not hold, the S&P 500 index may fall into the 3,550-3,600 mark and if even that is breached, may break down further to the 3,250-3,300 level.

While momentum indicators show some signs of over-sold conditions, it may be too early to expect a meaningful recovery of the S&P index anytime soon as sentiments and pockets have been severely bruised in the recent weeks of steep sell-offs.

Light at the end of the tunnel

Despite the gloominess in the markets recently, there are, however, those on the opposite camp who feel that fears of recession by the bearish markets are overblown and that we may already be at or near the peak of inflation and inflation expectations.

In their view, inflationary pressures should dissipate in the second half of the year, allowing the Fed to ease back on their hawkishness and for the markets to recover.

The writer is senior dealer, contract for differences, at Phillip Securities