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Cautious End to the Week

Stock markets are a little lower on the final trading day of the week. The European day got off to a decent start but that has fizzled out as the session has worn on.

It’s been quite an interesting week in the markets, in which one eye has been consistently on the Fed meeting next Wednesday. There’s been plenty of ups and downs but ultimately, we’re pretty much back where we started. With that now drawing ever closer, we could increasingly see caution among investors wary of the potential for a nasty shock.

There’s no doubt the downside risks are piling up and are coming from a variety of areas, be it inflation/monetary tightening, Covid, Evergrande, energy prices etc. The list goes on. But then we see US data this week – easing inflation, stronger retail sales and manufacturing activity – and suddenly there’s cause for optimism.

I think the risks are too hard to ignore at the moment, especially if the Fed and other central banks are so intent on removing stimulus measures. And it’s not the fact that economies around the world aren’t doing well, or that many of these countries now have high vaccination rates, but there’s so much uncertainty in the months ahead, the timing strikes me as a little odd.

While it’s also impossible to ignore the commentary coming from various central bank officials in recent weeks, I feel they may be persuaded to wait until the turn of the year if some of the downside risks unfold over the next couple of months and investors become anxious.

Next week should clear up some of the confusion as the Fed commentary we’ve had recently doesn’t seem to align with the mood in the markets. This week’s data from the US has alleviated some of the concerns but ultimately, if the message from the Fed is that its planning to reduce asset purchases regardless of downside risks due to inflation concerns, a taper tantrum may swiftly follow.

Eurozone inflation jumps, UK Retail Sales slump

It’s not just the Fed that’s seeing plenty of internal debate about inflation risks. The ECB – whose inflation problem has for years been an inability to generate any – is also experiencing above target of inflation. It rose to 3% in August, 1.6% on a core basis, and may rise further into the end of the year.

The ECB was forced to reject a story on Thursday that suggested the central bank may envisage a rate hike late in 2023 based on inflation projections over the next five years. I mean, aside from the story being based on private comments that were rejected, the idea of five year ECB inflation projections being taken seriously is laughable.

The UK is a more serious conversation when it comes to interest rate movements but expectations here even seem a little optimistic. The economy is in a decent position, much better than once imagined, but I’m not convinced two rate hikes next year is likely.

A retail sales decline of 0.9% in August supports a more cautious view, especially when combined with headwinds facing consumers over the next year including the end of the furlough scheme and Universal Credit boost, income tax threshold freeze, 1.25% increase in national insurance contributions and higher energy prices. Not to mention the more restrained behaviour in the event of a winter surge in Covid cases.

Oil eases off highs

Oil prices are pulling back a little at the end of the week after coming within a whisker of summer highs on Wednesday. We’re clearly seeing some profit-taking kicking in on approach to those highs, with the restarting of operations in the Gulf of Mexico and the dollar rally further backing the move.

Any correction in price could see some support arrive around $70 in WTI, where it finally broke back above earlier this week. There still appears plenty of momentum in the rally which could keep dip buyers interested. There’s also a couple more months of Hurricane season so further disruption in the Gulf is likely.

Gold stable after plunge

Gold took a pummeling on Thursday. A break of key support around $1,780 followed by stronger US retail sales and manufacturing data was a hammer blow for the yellow metal which rapidly fell below $1,750 before paring some of those losses. It’s making minor gains today but struggling to even maintain them.

It seems traders view the risks next week as being tilted to the downside for gold and have started pricing it in early. It’s not an outrageous assumption given the commentary we had from policymakers ahead of the blackout period, especially when combined with yesterday’s data, but it may be a little premature.

I imagine the Fed will want to remain committed to its desire to taper later this year but if they do, I expect there’ll be plenty of dovish caveats designed to keep the markets on board. And this may spare gold in the short term as we wait to see if the downside risks materialise.

Still waiting

There isn’t too much to add on bitcoin, not a lot has changed over the last few days. To the upside, $48,000 continues to look interesting and a failure to break above here could add to the case for a correction. A significant move below $44,000 and a correction could be underway (finally) which could make things a lot more interesting.

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