Written by Is this the first leg of a protracted correction?
At the start of the month, November was advertised as one of the strongest months for US equity indices, with this expected strength most likely feeding into other risk assets. Instead, on Monday, the largest global stock indices posted solid losses once again, led by US small capitalization indices such as the Russell 2000.
The Nasdaq 100 index is down 4% in November, underperforming other major indices, matched only by the weakness seen at the Nikkei 225. Interestingly, October marked the sixth consecutive positive month for the Nasdaq, equaling a similar positive run seen in the December 2016-May 2017 period, during the first few months of US President Trump’s first term.
Notably, the current risk-off episode began with cryptocurrencies selling off aggressively since early October. Bitcoin is currently experiencing its second straight double-digit weekly loss, dropping below the $90k level for the first time since late April, when risk markets were recovering from the announcement of Trump’s reciprocal tariffs.
The king of cryptos has surrendered most of its post—tariff-announcement rally, while the S&P 500 index still stands tall with a 50% gain since April 7, most likely supporting certain crypto-doubters who have been repeatedly highlighting the lack of intrinsic value in cryptocurrencies compared to equities.
Gold is misbehaving once again
On its way higher, it was repeatedly commented that gold was defying gravity – rising to the fresh all-time highs without major macroeconomic or geopolitical catalysts, or a significant dollar devaluation. Similarly, the precious metal is now defying its historical safe haven pedigree. Despite weakening risk sentiment, gold has dropped towards the $4,000 level, erasing last week’s rally. The outcome of the battle at this threshold will most likely determine the next leg in gold.
How could this wounded risk appetite reverse?
Fed rate cut expectations for December play a key role in the current negative risk appetite. Specifically, the chances of another 25bps rate cut in three weeks’ time have dropped to 42%, down from 90% before the late-October meeting.
This is a classic example of markets running ahead of themselves and pricing in another rate cut. However, there was merit in this reaction; the longest-ever US government shutdown is expected to have a significant impact on both economic activity and investment appetite.
That said, the current hawkish Fedspeak has hit hard these dovish expectations, with equities trying to find a new equilibrium. One could argue that investors understand that there is a strong likelihood of a pause in the current Fed easing cycle, and they are trying to engineer a sell-off. A solid correction might scare Fed members, activate the “Fed put”, forcing them to announce a December rate cut without clean and representative data. Coupled with lingering liquidity concerns, financial stability could be the official justification of further easing.
Incoming data and Nvidia earnings could set the tone for a rally
With several investment houses posting bullish reports about stock markets, the current weakness might prove short-lived. Stelar Nvidia earnings and less-hawkish-than-currently-feared FOMC minutes on Wednesday, along with a soft September nonfarm payrolls report on Thursday could give a temporary boost to risk assets.
Additionally, Fed doves are likely to take advantage of such developments to counter the continued hawkish commentary. Notably, equities are currently sensitive to dovish remarks, as seen by yesterday’s reaction to Fed Governor Waller repeating his support for a December rate cut.
Dollar searches for direction
The minimal movements in the FX space continue, with dollar/yen remaining in the spotlight. Monday’s weak Q3 GDP report from Japan, and further commentary about the size of another fiscal stimulus programme have kept the yen under pressure. Coupled with reports that Japanese PM Takaichi is considering tax cuts, the outlook remains bearish for the yen, with verbal intervention escalating.
By XM.com
