Service sector

EURUSD forecast will be based on rate projections and US services sector report

Talking Points S&P 500, EURUSD, Yield Curve, Fed, Dollar and AUDUSD

  • The business perspective: USDJPY bearish below 121; AUDUSD Break from 0.7550 to 0.7450 Range; Crude Oil bullish above $100
  • Data from Russia and energy prices offer important insight into the effects of the 39-day assault on Ukraine, but monetary policy may be a more pressing topic
  • While the RBA’s decision is the most important, dovish Fed keynote speakers and the US ISM services sector report may be the most important update amid yield curve inversion

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Many threats but a functioning market with a ‘low risk’ reading

We kicked off the first full week of April and the second quarter with a broad but uninspired increase in risk assets. With so many active headwinds facing this market – inflation, interest rates, growth forecasts, Russia, etc. – it is difficult to envisage a systemic bullish trend truly taking over. Nonetheless, the S&P 500 was up 0.8% while the Nasdaq 100 was up 2.0% through Monday’s close. This move was supported by a similar drift in global indices, emerging market benchmarks (eg EEM), junk bond measures (eg HYG) and carry trade. Speculative conviction doesn’t always come from a singular or compelling catalyst, but we don’t appear to be on the technical cusp of a larger market like the S&P 500. We’re trading comfortably within last week’s range while the SPDR ETF – one of the most traded derivatives in the world – hit its lowest volume of the year.

Chart of SPDR S&P 500 ETF with 20-day SMA, volume and 1-day rate of change (Daily)

Chart created on Tradingview platform

Another point of serious disparity for me in market-based confidence comes from the VIX’s implicit measure of risk. The volatility index derived from S&P 500 options (download our introductory guide to options here) has been dubbed the “Fear Index” due to its inverse correlation to the underlying index; in other words, it tends to recover when capital markets are exposed or expected to be exposed to risk. As the stock market has advanced over the past three weeks, many fundamental threats are at hand. That said, the lowest Volatility Index reading since Jan. 12and seems more the performance of a delayed measure than an advanced measure. Such discord does not mean we need to reverse the trend any time soon, but it does suggest that the market is poorly positioned for further shocks.

VIX Volatility Index Chart with 20 and 200 Day SMA (Daily)

EURUSD forecast will be based on rate projections and US services sector report

Chart created on Tradingview platform

Fundamental Updates: Russia; Monetary policy and growth

In assessing the level of market activity and the direction to take, we need to take stock of the most significant and unresolved risks in the system. The Russian invasion of Ukraine has passed its 39and day and the human toll continues to grow. Amoral markets, however, react more to economic and financial implications. It may seem that we have passed this theme as a permanent threat with last month’s recovery, but there are more abstract risks that have not been fully registered. Commodity price inflation following the war and sanctions continues to play out, with WTI crude oil bouncing above $100 a barrel before hitting the midpoint of its run from December 2021 to March 2022. Futures contracts for gasoline, liquefied natural gas and grains are even less flexible. The broader financial toll of Russia’s disconnection from the global system carries serious risk in itself and is not at all clear. The country has paid three-quarters of a $2.2 billion bond payment, but it was not yet known that the balance had been cleared – which is in danger of default. Then the JPMorgan CEO warned that the dispute could cost the world’s largest bank up to $1 billion. Those are the macro concerns I have the most, but I’ll still be watching for Markit’s March release of the country’s own PMI indices.

Table of major macroeconomic events

EURUSD forecast will be based on rate projections and US services sector report

Calendar created by John Kicklighter

If you’re looking for a fundamental theme that can generate more consistent traction in the markets, I think monetary policy will continue to put pressure on relative valuations of regional assets and collectively influence the risk/reward view across the financial system. In terms of monetary policy, rising commodity costs are trickling down to consumers and prompting key policymakers to respond with benchmark rates and adjustments to their stimulus programs. Markets have been very good at pricing the former, but the plans and implications of quantitative tightening look nebulous compared to how the market assesses risk. On that front, meeting minutes from the Fed, ECB and a few other central banks this week may offer some key insights. Over the weekend, even members of the notoriously dovish ECB discussed ending the QE program and rate hikes thereafter towards the third quarter – although chief economist Lane hedged his bets by due to uncertainties.

Chart of Central Bank monetary policy stance with rate forecasts

EURUSD forecast will be based on rate projections and US services sector report

Graphic created by John Kicklighter

The markets with the most potential and the dormant theme

Putting the themes to work, there are specific markets that I will look to in order to reflect the fundamental themes. In general, it does not seem urgent to resolve the general tension of feelings; so I don’t have explicit expectations for stocks like the S&P 500. That said, there is separate potential for event risk like the RBA’s rate decision. The market did not fully assess any change at its meeting on Tuesday, but is also certain of movement in June. Such conviction on both sides offers the opportunity to surprise in both directions. For AUDUSD, it looks like a breakout of a tight range, but EURAUD is trending lower, helped by the Euro’s own fall. EURUSD has slipped in the last session below 1.1000, but a real breakout is still ahead of us. That said, I’m also keeping an eye out for Fed speakers scheduled for Tuesday afternoon (especially Lael Brainard who is perhaps the most dovish member now) as well as headlines from the BOJ and Japan’s Ministry of Foreign Affairs. Finance. The potential for intervention from the Yen looks high.

EURAUD chart with 20-day SMA (daily)

EURUSD forecast will be based on rate projections and US services sector report

Chart created on Tradingview platform

While monetary policy is a comprehensive enough fundamental theme, I will also be watching the headlines and trading room discussions around growth very closely. A slowdown in the economic outlook hasn’t been enough to rattle this market lately, but the word “recession” has been floating around more aggressively lately. This is partly due to the inversion of the 2-10 yield curve (the difference between the yields of 10-year and 2-year US Treasuries). When this particular part of the curve turns, many investors interpret it as an advance warning of a recession. The signal balance is quite good over the last half century. The negative reading through Friday topped the September 2019 slide and is comparable to 2007. If the U.S. ISM services sector activity report for March, due Tuesday in the New York session, extends the rapid fall in recent month ; this backdrop can be a considerable fundamental fuel.

Chart of 10-year to 2-year US Treasury yield spread, ISM services and manufacturing activity (monthly)

EURUSD forecast will be based on rate projections and US services sector report

Chart created by John Kicklighter with data from FRED and ISM

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