AUTUMN HAS COME: NEW SEASON OF FINANCIAL MARKET

By Elizabeth Belugina, head of analytical department at FBS

Elizabeth Belugina
Elizabeth Belugina

As the holiday season is at an end, time comes for traders and investors to reassess the economic outlook and invent new trade ideas. The general public also awakens from the summer hibernation and wants to make some investment decisions. In this article we will make a review of the current financial situation in the world and outline the prospects for the main assets.

Macroeconomic picture

Developed economies remain heavily dependent on monetary help from central banks. So far, Brexit decision hasn’t led to the economic apocalypse predicted by many analysts as it’s clear that Britain won’t immediately part with the EU. Financial markets were quick to digest the shock. As for the economy, it seems that the United Kingdom may avoid recession: Moody’s predicts growth of 1.5% this year.Despite uncertainty about the nation’s future British economy is getting help from monetary and fiscal stimulus. Elsewhere the euro area’s and Japanese economic growth remains anemic and inflation keeps undershooting the target level. All in all, growth may be characterized as sluggish, but for now the situation doesn’t appear critical.

The United States stands apart from other advanced nations. On the one hand, growth of the world’s leading economy slowed down to just 1.1% in June quarter. However, industrial production, durable goods orders and residential construction give reasons to believe that we’ll see better figures in Q3: Atlanta Fed projects 3.5% growth. American labor market seems to be in good shape and consumer sector is strong. Low inflation though remains one of the main obstacles to rate hikes in the US: core personal consumption expenditures index (PCE), the Fed’s preferred inflation measure,rose by 1.6%y/y in July that is below 2% target.

Emerging market economies, which attracted a lot of capital in past months, do not actually have solid economic fundamentals. Many of them depend on China with its unbalanced economy, which experience a clear slowdown. In August, Moody’s raised its short-term outlook for the emerging market economies, which are part of G20, but still they are extremely vulnerable to potential US rate hike: if America raises interest rates, this will lead to a major outflow of cash from emerging markets back to the US.

Currencies

The main question of interest for Forex traders is the timing of US interest rate hikes. The autumn Federal Reserve meetings will take place on September 21 and November 2. It seems that the US central bank will ultimately have to tighten policy as it did promise to act this year and is running out of excuses not to do so, but a rate hike is more likely in December than in the autumn months. Although the inaction in September may once again hurt the greenback, the closer the winter, the stronger the expectations of a hike and, consequently, the US currency should become. US dollar index remains in a broad sideways trend. By the end of autumn, it will likely move towards its upper border in the 99.00/100.00 area.

US dollar index, weekly chart
US dollar index, weekly chart

The single currency lacks fundamental reasons to strengthen because of the loose monetary policy of the European Central Bank, which is already set in place. However, EUR/USD has been trading in a rather stable fashion in the recent months.It happens because of the euro area’s large current account surplus and the fact that fragile European banks don’t feel good enough to invest money abroad, so monetary outflows from the region are limited.Taking into account the fact that the euro is off highs, there’s the risk that the ECB doesn’t deliver new monetary easing expected by some analysts. In the absence of September rate hike in the US, odds are that EUR/USD will continue moving sideways fluctuating around 1.1100.

Japanese yen retreated from highs, but for the time being it will be very hard for USD/JPY to reverse the downtrend. Analysts expect the Bank of Japan to ease policy on September 22, but at this point it will be really hard for the regulator to exceed the market’s expectations. That’s why there’s the risk that any new BOJ measures stimulus measures will have limited impact on the currency market. Strong psychological support at 100.00 is the key level to watch on the downside. In case of good economic data from the US combined by monetary easing from the Bank of Japan and other central banks, resistance for USD/JPY will be at 107.50 and 110.00.

Commodities

Oil price rose on speculation of output freeze talks by the world’s largest producing nations.The market is focused on International Energy Forum in Algeria on September 26-28. However, discord in the Organization of the Petroleum Exporting Countries (OPEC) is still severe and the possibility of an agreement isn’t high. Moreover, production levels in both OPEC and non-OPEC members are at the record highs, while production in Nigeria is recovering after the disruptions, so even if there is a deal to freeze the output at the current level, it won’t have a sizeable impact on the immense oil supply.From the demand point of view note that many refineries will stop operation for the seasonal maintenance ahead of winter. As a result, it would be very hard for Brent to stick around $50 mark. According to Reuters poll, Brent would average $45.44 a barrel in 2016. Up to this point this year’s average was about $42.6.

Brent oil, daily chart
Brent oil, daily chart

Gold is one of this year’s best performing asset, despite consolidation in the last two months. Recently the precious metal was under the negative impact of the increased US rate hike expectations. The prospect of higher interest rates makes gold less attractive to investors as the metal doesn’t provide yield.Demand for gold jewellery, which accounts for more than half of total gold demand, declines because of higher price.However, expansionary monetary policy of the most major central banks and negative interest rates in Europe and Japan in particular is a supportive factor for gold. In addition, things like Brexit, Italy’s troubled banking sector and geopolitical tensions in the Middle East are still capable of creating risk aversion. All in all, gold may appreciate in the medium term, but the overall strength of American economy and the Fed’s policy tightening won’t allow it to make a big rally.

Stocks

The resilience in American stock market may be largely explained by the approaching US presidential election due on November 8. At the moment the consensus is that Hillary Clinton will replace Barack Obama at the job. The Democrats are expected to retain the White House, while the Congress will be split into Democratic Senate and Republican House. Such layout would mean that the divided leadership won’t be able to produce any fundamental changes in economic policies. In this case the Federal Reserve will have to keep taking care of the economy. Such scenario is good for risk sentiment and for markets as it represents a blissful thought that there are no shocks ahead. Clinton is now ahead of Trump, but should the lead narrow ahead of the election, uncertainty may cause spike in volatility as the market is now pricing too big a chance of Clinton’s victory. This should provoke bearish correction in American equities.Trump victory may lead to a fiscal stimulus and strong USD. The first debate between Trump and Democrat Hillary Clinton will take place on September 26.Other risks for stocks include US interest rate hike and decline in oil.

S&P 500, daily chart
S&P 500, daily chart

Emerging-market stock shave risen by more than 20% over the past six months. Taking into account the crowded positioning, riskier assets are ready for correction, at least on profit taking.

Conclusion

With the end of summer volatility is bound to increase. US Presidential election, talks between oil exporters and expectations of action from major central banks (tightening from the Fed and easing from the ECB, the BOE and the BOJ) will make autumn a busy season. High-yielding assets have been recently in great demand, but the ability of this trend will depend whether the central banks keep fueling it by easy monetary policy. More easing from European and Japanese central banks, Federal Reserve on hold in September, Hillary Clinton becoming the US president will make riskier assets enjoy more gains. At the same time, risk of uncertainty associated with the upcoming events can give the market reason for correction. Other risks not discussed in this article include Chinese yuan devaluation and the maybe bubble in sovereign bond market.

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