MARKET OBSERVER – N° 158

The luring distraction constituted by the dramatic ongoing conflict on the eastern borders of Europe continues to divert attention from the real problem that weighs on the prospective dynamics of international securities markets.

Examining monthly data made available by the US FED, it is clear that since last December, when Governor Powell removed the word “transitory” from his speech in reference to the ongoing inflationary upsurge, the central bank had already drained a trillion dollars from the credit market. Consequently, the global index relating to the liquidity of central banks, overall, is at the lowest level in three years; amounting to 28.3 trillion dollars, a reduction of 818 billion in April alone. The lion’s share of this monetary tightening concerns precisely the FED which by reducing its balance sheet has pushed the dollar upwards also to reduce imported inflation. The recent admission by the Governor that the FED has been slow to react to the increase in inflation implies that by the end of the phase of gradual increases in the base rate, probably in early 2023, it could reach 3%, rendering fixed income securities in dollars with maturities between five and ten years attractive, based on the assumption that the US economy does not go into recession and therefore the yield curve remains marginally positive. The hypothesis that the same will remain positive is also supported by the recent dynamics of commodity prices which, through their current stabilization, would seem to indicate that this month could coincide with the peak in trend inflation data. The real macroeconomic problems are concentrated in Asia, where the Bank of Japan has decided on a reckless defense of the yield at 0.25% of its ten-year debt which caused a collapse of the Yen against the dollar, amounting to a drop of 13% since the beginning of the year, which also forced the Chinese PBOC to intervene with a tightening action to defend its currency. If we consider that China is also grappling with a serious pandemic resurgence that is causing major production stoppages, important negative effects on global industrial activity are already perceived, compatible with a prospective decline of inflation. Quantifying the Chinese currency problem, foreign exchange reserves have contracted by 4% since the beginning of the year, forcing the credit tightening that will have important economic repercussions.

In essence, in just a few short weeks, the 2016 Shanghai agreement, which for five years had guaranteed the stability of the primary currencies of the Asian economic area, was blown up. As for the stock market indices, always taking the US S&P 500 index as a reference, the week ended with the first serious attempt at a technical rebound from oversold since mid-April with the index recovering the technical resistance at the 4000 level, making it possible to continue trending upwards toward 4150. This hypothesis is based on the dynamics of the bear market rallies, which see the subsequent technical rebounds of approximately 50% of the preceding move; therefore, in the present case, we can expect a bounce of about 200 points. Given the persistent underlying weakness in equity indices and the lack of geo-political signals that could herald an upcoming solution to the Russian-Ukrainian conflict, even a modest upside should be utilized to reduce equity exposure, awaiting more compelling valuations of the indices, probably in the 3300 / 3500 range, given that the FED triggers P/E multiple compression by raising interest rates while the PBOC is slowing global economic growth.

Nicola Bravetti data source: Bloomberg

Data Obtained on 16.05.2022 – 11.00 GMT
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