European stock markets edged a little lower but were well within recent ranges early on Monday as investors look ahead to a key Federal Reserve meeting this week. Wall Street ended a positive week on a more cautious note on Friday as Snap’s (NYSE:SNAP) earnings miss hit tech, with Alphabet (NASDAQ:GOOGL) down almost 6% and Meta (NASDAQ:META) more than 7% weaker for the session. Futures indicated a slightly lower open later. We get both sides of the PE multiple this week with the Fed and a deluge of earnings from some of the largest weightings on the market.
The S&P 500 is about 9% above its June lows. The bump is down to a couple of things. One earnings are pretty good. However, Friday saw how bear market rallies can reverse as quickly as they begin when the narrative unwinds– a Snap-led tech sell-off saw the S&P 500 decline 1%, though the market still ended 2.6% higher for the week.
The other side to the rally is the market thinks slowing economic growth and possible recession will see Fed and other central banks take their feet off the pedal sooner and even cut rates next year – these bets will get pushed back. The Fed won’t back down until inflation goes below 5% at least and we know from history that it will likely need to nudge rates up past 5%, implying 250bps worth of hikes beyond the 75bps expected this week. As inflation is not peaking and going back to normal, but rather plateauing, so too will central bank policy – higher for longer. Stocks won’t like it. This a dangerous moment for bulls – the bull trap – more rate hikes are coming and markets will need to acknowledge that the Fed won’t be cutting anything like as soon as expected - that is when the capitulation can happen.
Everyone is looking for a blow-up so this bear market rally needs to be viewed in this context – everyone is pessimistic yet the market is rallying since the market will always seek to do maximum pain to the most people. Call open interest tied to the VIX jumping to or above 40 is at a record, notes JPM.
More from JPM: "Equity positioning for systematic and macro strategies remains near historic lows, and can continue to support the recent market bounce. Hedge Funds and Asset Managers are record short US equity futures, CTAs remain net short equities.”
Elsewhere, the dollar is a littler lower around 106.66, well off the highs of two weeks’ ago when DXY traded above 109. GBPUSD is a little under 1.20 still and struggling to make a meaningful breach higher. EURUSD is a little under 1.02 this morning. Oil trades lower, with front month WTI at a one-week low and gold is a bit weaker after hitting resistance at $1,740.
This week
Markets expect the Federal Open Market Committee (FOMC) to deliver another bumper rate hike after its meeting on July 26-27. The question is how big: markets expect a second 75bps but price a roughly one-in-three chance of a full percentage point increase in the Fed funds rate. The Fed will need to balance competing influences on policy thinking. Whilst nominal inflation continues to rise to 40-year highs and exceed expectations, inflation expectations and commodity prices have somewhat rolled over in the last month. And whilst the CPI inflation reading keeps trending higher, core PCE inflation has eased back.
The advanced reading of US second quarter GDP growth is due Thursday. The Atlanta Fed’s GDPNow model estimate for real GDP growth in the second quarter of 2022 is -1.6 percent on July 19th, down from -1.5 percent on July 15th. If it were to do, it could signal the US economy has entered a technical recession, after first quarter GDP declined by 1.4% on an annualised basis.
The Fed’s preferred gauge of inflation, the core personal consumption expenditures (PCE) index, is released on Friday. Figures released at the end of June showed PCE inflation excluding food and energy fell to 4.7% year on year in May, down from 4.9% in April, with the core inflation reading having peaked at 5.3% in February. Headline PCE inflation was steady at 6.3% in May, down from a March peak of 6.6%.
Earnings season hits full speed this week as the largest cap companies and a slew of Dow industrials post quarterly financials. So far about four in five companies on the S&P 500 that have reported topped analyst expectations. Thus far earnings have not been as bad as feared and that is allowing investors to see the glass half full after weeks of worry. Megacap tech is the highlight with Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Alphabet, Meta and Microsoft (NASDAQ:MSFT) on the tape. Meanwhile, Dow components McDonald’s (NYSE:MCD), Coca-Cola (NYSE:KO), 3M (NYSE:MMM), Intel (NASDAQ:INTC), Procter & Gamble (NYSE:PG), Chevron (NYSE:CVX), and Boeing (NYSE:BA) are among the other major companies delivering earnings updates.