- Will FOMC signal QE taper? We doubt it even as economy in better shape and inflationary pressures on the rise
- Fed might have to tighten its belt faster eventually
- Growth stocks may struggle going forward and dollar set for comeback vs. JPY and CHF
- Facebook and Apple earnings coming up
- FTSE edges higher as Lloyds beats
The European stock markets edged higher on stronger company earnings results, while the dollar also found some support with speculators reducing their bearish bets on the greenback ahead of the FOMC’s policy decision in case there is a hawkish surprise in the policy statement or during Powell’s press conference. The focus also remains on tech earnings with Apple and Facebook to come later.
Will FOMC signal QE taper?
As much as I think the Fed should be starting to prepare the market for asset purchases reduction, I am doubtful it will do so at this particular meeting. The FOMC will likely re-iterate that the labour market slack remains too high, even if the economy is in a better shape than in March and more signs of inflationary pressures are evident. I think the Fed will wait until the June meeting when the FOMC will have the updated economic and inflation forecasts to work with.
Still, there is the potential for a hawkish surprise and that’s why bond yields have started to rise again, with investors also easing the selling pressure on the dollar in case the Fed does catch the market off guard. Fed Chair Jay Powell is likely to acknowledge that economic conditions have improved but will probably stop short of providing any clear hints as to when the Fed will actually taper QE. If he sounds more hawkish than expected, then the markets may see that as a sign that the Fed is getting worried about inflation and that it might decide to withdraw support quicker once it starts the tapering process.
Inflationary pressures on the rise
Indeed, inflationary pressures are building up. We’ve seen big rises in commodity prices such as copper, iron ore and lumber. Prices of soft commodities have also risen sharply with wheat, soybeans, coffee and cotton all pushing higher. Don’t forget that housing costs are on the rise too.
With margins tight, producers will likely pass on these raised input costs onto consumers. So it will be only a matter of time before the CPI overshoots the 2% target and there is a risk that inflation could be more sticky than the Fed expects.
Growth stocks could struggle and dollar set for comeback
In fact, by keeping the QE taps wide open, the Fed are only fuelling the fire, which will eventually require faster tightening to put out the flames.
Against this backdrop, you would have to think that the US equity markets, especially growth stocks whose yields are low, might struggle going forward (see below for more). The dollar is also likely to come back against some weaker currencies, especially against those where inflation is not too much of a concern – such as the Japanese yen and Swiss franc.
FTSE lifted by more upbeat earnings from UK companies
The FTSE maintained its bullish bias as more earnings beat expectations. After stronger-than-expected results from the likes of BP and HSBC yesterday, Lloyds Bank has also beaten expectations on profits, sending its shares over 3% higher and helping to underpin the UK index ahead of FOMC meeting. Lloyds revealed pre-tax profits of £1.9bn for the first quarter, which was much higher than city expectations. It comes after a boom in home lending as buyers have rushed to take advantage of stamp duty holiday ahead of its end of June deadline. The release of £459m in provisions that had been set aside for soured loans has also helped the lender posting solid results.
All about tech earnings on Wall Street
Meanwhile, on Wall Street, tech earnings continue to pour in. Microsoft and Google parent Alphabet both posted surging profits after the closing bell last night. The latter saw its share surge 4% in after-hours trading as sales were boosted sharply by an increase in digital ad spending by businesses and as it authorized the repurchase of up to $50 billion of its own stock. Microsoft saw firm demand for its cloud services while personal computer shipments were the strongest in more than two decades. However, its share slipped as some demanding investors were presumably not too impressed. AMD saw its shares rise as it met EPS expectations while sales surged. Apple and Facebook will report their results after the close tonight.
Tech sector faces key tests in coming months as earnings pour in
The tech sector was among the biggest beneficiaries of the lockdown but as Microsoft, Tesla, Netflix and Intel remind us, past performance is not necessarily a good indicator for the future. The lack of further bullish follow-thru for some of these shares despite decent results may be sign of things to come for the sector.
It is possible that the bar may be set too high for these companies to beat. In addition, investors are looking ahead and would be wondering what will drive their shares as economies end lockdowns:
Working from home may soon become a thing of the past for many employees and other pandemic-driven consumer preferences are going to evolve. This might have major implications, especially for the technology sector. For example, companies with subscription-based services might struggle to win new customers the same way they did during lockdown when people stayed at home mostly and purchased services online. Taking Netflix as an example, its subscriber growth slowed far faster than anticipated in Q1 and was the smallest first quarter gain in four years. Its shares slumped, even though it reported better-than-expected top and bottom lines. So, it is going to become increasingly difficult for these types of companies that excelled last year to keep up pace. Investors will be focusing on what company execs will be highlighting about the changing behaviour of consumers in their quarterly reports and earnings calls, than just merely concentrating on the top and bottom lines.
Another big risk facing US companies is tougher regulations and higher taxes for the richest Americans. President Joe Biden and the Democratically-controlled Congress will be keen to regulate tech giants, with regulators continuing to pursue anti-trust actions against the likes of Apple and Alphabet. Meanwhile Biden’s proposal of nearly doubling levies on capital gains for people earning more than $1m could provide a massive blow to the equity markets, if it ultimately passes in a form similar to the initial proposal. It could discourage the richest Americans who are likely to own shares from allocating money towards long-term investments. They might sell shares before the tax increase becomes low, potentially derailing the stock market rally.
Meanwhile, as global lockdown measures are slowly likely to ease, things will hopefully return to more normal ways in the coming months. The US economy is likely to rebound strongly, and inflation will probably heat up as a result, requiring tighter monetary policy as a result. If the Fed were to start tapering bond purchases later in the year, this will likely put upward pressure on bond yields. Rising yields are seen as negative for the growth stocks, whose dividend yields are comparatively lower than what you would get from fixed income.