3 potential opportunities in Q3

June 30, 2022

– For Q3, investors and traders worldwide are set to continue obsessing about similar themes that have rocked markets so far in 2022:

Inflation
Rate hikes (or the lack thereof) by major central banks
Recession risks and how it impacts Wall Street earnings

As we count down the hours before the third quarter rolls along (and marvel yet again at how quickly time flies), let’s filter those three market themes down to how they might impact these major instruments/assets:

EURUSD
USDJPY
S&P 500

EURUSD to move lower and closer to parity?

EURUSD has been finding it hard to stay above its 50-day simple moving average – a key resistance level for the world’s most-traded currency pair over the past 12 months.

This downtrend in EURUSD reflects two major factors:

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The US economy’s healthier outlook relative to the Eurozone’s. After all, there’s still the Russia-Ukraine war raging off to the latter’s eastern borders.
The Fed’s plans for more incoming rate hikes appears to be less risky than the European Central Bank’s.
The ECB is just only getting started, with two rate hikes slated for Q3. But markets fear that the incoming ECB hikes could inadvertently result in a sovereign debt crisis/fragmentation risks.

Overall, if the EU’s economic outlook turns darker than the US, which implies that the ECB can’t hike its benchmark rate as fast as the Fed, that could lead to more downward pressure on EURUSD.

If the above assumption holds, EURUSD could be dragged and kept below that psychologically-important 1.04 level in Q3.

At the time of writing, markets are forecasting a 72.5% chance that EURUSD could reach even parity sometime over the next 3 months!

Though to be clear, the same odds are placed on EURUSD recovering back to 1.09.

Much will depend on how much the outlooks differ between the US economy/Fed vs. Eurozone economy/ECB.

Key events to watch for EURUSD:

Economic data out of the EU and the US (especially the monthly consumer price index)
Market expectations for the July and September policy meetings for both the ECB and the Fed
August 25-27: Fed’s Jackson Hole Economic symposium – a key event which often sees the Fed offering a big signal to the markets about its policy outlook

2) USDJPY to climb above 140?

USDJPY has reached its highest levels since 1998, skyrocketing past previous peaks set in 2015 and also in 2002 with such ease.

The soaring USDJPY reflects the widening policy gap between the US Federal Reserve and the Bank of Japan.

In June, the Fed raised its benchmark rates by 75-basis points – its largest hike since 1994 – and now at 1.75%.
Meanwhile, the Bank of Japan appears content to keep its policy rate in negative territory, at minus 0.1%.

This divergence has also seen 10-year US Treasury yields soar past 3%, while Japan’s equivalent remains capped at 0.25% by the Bank of Japan.

In other words, global investors would be more enticed by the higher yields on offer in the US, creating more demand for the US dollar … as opposed to Japanese yields (less demand for JPY).

This divergence is set to persist in Q3 as well, which should translate into more upside for USDJPY.

Markets are forecasting a 74.7% chance that USDJPY could reach 144.93 over the coming months.

However, there’s also a similar-sized chance that USDJPY could plummet back down to 125.847, which was also its June 2015 peak.

A significantly lower USDJPY would require Japanese policymakers to stem the Yen’s declines, either by intervening in the FX markets or by way of the Bank of Japan shockingly pivoting to a hawkish tune (signal that it would start raising interest rates/raising its yield curve control targets).

Key events to watch for USDJPY:

What is said by officials out of the US Federal Reserve vs. the Bank of Japan
Yields in Japanese government bonds vs. US Treasuries

3) S&P 500 to fall deeper into bear market, reach 3500?

At the time of writing, the S&P 500 index – which is the benchmark used to measure the overall performance of the US stock market – is set to re-enter a bear market.

NOTE: A bear market means that the price of an asset has fallen by 20% from its recent peak.

Although fears of a US recession have been dominating market chatter of late, the S&P 500’s drop so far this year has yet to fully reflect such risks.

Stock bulls (those hoping that an asset’s price will climb) are hoping that US consumers are resilient enough to keep generating revenue and profits for these publicly-listed companies.

And this is where the upcoming US earnings season would play a pivotal part in the S&P 500’s performance.

If Wall Street can continue sounding optimistic about its earnings outlook, and markets can believe in such optimism, that could shore up support for the S&P 500.

However, the likelier scenario appears to point the S&P 500 closer to 3500 or lower in the second half of 2022, as markets brace for earnings downgrades and more warnings about a US recession, especially if the Fed is forced to trigger more larger-than-usual rate hikes in its battle against stubbornly persistent red-hot inflation.

Key events to watch for the S&P 500: