Stagflation, a time of high inflation and weak economic conditions remains the talk of the town this week, particularly after the Atlanta Fed cut its Q2 GDP forecast to -2.3%, implying that following a negative Q1, the US may be in a recession.
Although the S&P 500 is coming off of its worst first half to a year since 1970 with a decline of just over 20%, US equities have not taken the brunt of recession talk this week, major indices have been stabilizing. The biggest response to recession talk has been in commodity markets, where WTI crude oil has plunged below $100.00/bbl, and copper has continued the downward spiral we mentioned in last week’s edition of the Equity Leaders Weekly. Overseas equities have also remained under pressure.
Capital rotating out of overseas markets and commodities and looking for a lifeboat has flowed into the US, sparking a big rally in the US Dollar. Even other defensive havens like gold have been unable to stand up to the strong US Dollar. Australia’s Dollar fell on a day when it’s central bank hiked interest rates by 0.50%, but the biggest casualty of the week has been the Euro which has fallen to its lowest level in twenty years and is trading just above par.
The remainder of this week is dominated by employment and wage inflation numbers from the US and Canada. Next week starts off quietly then picks up midweek with US inflation reports and wraps up next Friday with US retail sales. Investors may continue to look to economic reports for indications of whether a recession is taking hold in North America and how much pressure inflation is putting on central banks to continue tightening monetary policy.
Speaking of central banks, the Bank of Canada’s next interest rate decision arrives on Wednesday. Last time around, Governor Macklem and co raised the overnight rate by 0.50%. Since then, the US Federal Reserve Board announced a 0.75% rate hike and there has subsequently been widespread speculation that the Bank of Canada could potentially step up and accelerate its rate hike program as well.
Earnings season in the US gets underway next week with reports from major banks, regional banks, and investment banks. Confession season, which has been fairly quiet so far, continues for other sectors.
In this edition of the Equity Leaders weekly, we look at the recent rally of the US Dollar relative to the Canadian Dollar, and preview the upcoming earnings season for US banks.
Increased US Dollar strength has manifested itself across the major currency pairs. USDCAD is currently getting squeezed between US Dollar strength on capital inflows, and Canadian Dollar weakness from falling commodity prices. The USDCAD pair has rallied up to a key resistance test near $1.3100, where a breakout would signal the start of a new upleg and confirm the start of a new uptrend. Should that occur, previous column highs and lows suggest resistance possible near $1.3400 then $1.3600, while a horizontal count suggests potential resistance near $1.3800. Initial support appears near $1.2850 based on a 3-box reversal. A breakout by USD could have a number of significant impacts on equity markets as well. Initially, a rising US Dollar would increase the relative strength of US stocks versus Canadian and International stocks all else being equal. In time, however, a rising US Dollar could present a headwind for US equities due to its potentially negative impact on the earnings of US exporters and US companies with large overseas operations. The impact of a rapidly rising currency is something that investors may watch for in US earnings and guidance, if not this quarter, then increasingly likely next quarter.
Although the steep declines in growth/momentum related sectors such as technology and communications have attracted more mainstream attention over the last six months, the US financial services sector has also been in retreat. A year-long uptrend in the Financial Select Sector SPDR (XLF) peaked back in January. Since then, XLF has been under distribution, establishing a downtrend of lower highs and bearish pattern completions.Currently XLF is on a bearish Double Bottom signal with a bearish SMAX score of 4. Although it has bounced back into a column of Xs, it would need to close above $33.33 to move onto a bullish low pole warning signal. Based on previous column highs and lows, upside resistance also appears near $34.35, and $35.75. Initial downside support appears near $31.10 based on a 3-box reversal, followed by a recent low near $30.50. A breakdown there would complete another double bottom and signal an new downleg with next potential support at a long-term trend line near $27.85. The financial sector has the potential to be active in the coming weeks with several seniors scheduled to report earnings. Three factors in results that investors may take particular note of are: 1) the potential impact of a positive spread (lending rates rising faster than deposit rates) for traditional banking operations. 2) the potential impact of a slowing economy on credit risk and loan loss provisions, and 3) the potential impact of a retreating stock market on investment banking and wealth management operations.
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