A sideways slide threatens stock indices

Last week the US labour market data came out weaker than expected but triggered an impulsive rally in commodities and stock markets, putting pressure on the US dollar.

EURUSD rallied from intraday lows at 1.2100 on Friday to above 1.2180 briefly. However, this momentum was not sustained, and the pair regained almost half of its gains, trading near 1.2150 by the start of trading in Europe.

For short-term speculators, the weak data supports the momentum of the stock indices, as the chances of a winding down of stimulus from the Fed are diminishing. That is what we saw in the market’s reaction after the jobs report last Friday.

But such tactics have a vulnerability. It assumes that policymakers are reasoning in the same way as the markets. That is not always the case. At the weekend, Janet Yellen, the US Treasury Secretary, said that higher rates could do more good. That is not how she reasoned when she was head of the Fed and was slow to normalise monetary policy!

For the long-term investors, market rallies on weak data look absurd. Stimulus raises the degree of activity in the economy. Still, once the regulators see signs that the “temperature” has normalised, i.e., the economy does not need to be pushed up, stock markets become vulnerable.

By and large, the United States market is experiencing just such a period: solid data and apparent economic progress risk triggering a correction in the markets, removing some of the froth whipped up by soft policies and fiscal stimulus from the markets. Longer-term investors may not be interested in joining in buying now while witnessing such market volatility, as the rule of thumb works for the long term: better for the economy – better for the markets.

Notably, the key stock indices failed to make new highs in May, gaining somewhat cautiously after a pullback since late April. The overhang at the start of the wind-down is preventing markets from returning to the standard response. This was already the case in 2014-2016 when markets experienced a prolonged sideways trend.

The FxPro Analyst Team