Market sentiment hit by Fed miscommunication

Equity markets kicked off the week in red on Monday with risk appetite seeming to be hurt by miscommunication from Federal Reserve. The probability of a 50-basis point rate cut by the Federal Reserve rose on Thursday after Federal Reserve Bank of New York President John Williams said the US central bank should take swift action when faced with adverse economic conditions. His comments led investors to believe that a more aggressive rate cut is underway when the Fed meets on July 30-31. However, a statement from the NY Fed stated that Williams’ speech was an academic one based on research and not about potential action at the upcoming Federal Open Market Committee (FOMC) meeting. The clarification from the NY Fed trimmed the probability of 50 basis point rate cut to below 20% from about 65%. In such time of uncertainty, messages from the Fed needs to be more coordinated and aligned to prevent shocks in the markets. The sentiment was even further dented on Friday after Iran captured the British oil tanker, increasing tensions in the already volatile region.

Surprisingly though, oil price gains were limited. Market participants would have expected prices to climb $10 to $20 given the rising tensions in the Strait of Hormuz, which is the most critical shipping route for Oil. Brent traded 1.6% higher on Monday, while still $4 below the previous week high. The little reaction seen in prices suggest two things. One, markets do not believe that these tensions will further escalate and two, the ongoing trade disputes will further hit demand while the US supply continues to reach new highs. While fundamentals do support lower oil prices, investors need to carefully watch the developments in Strait of Hormuz. After all, the Strait is responsible for one-fifth of the world’s oil supply, and any disruption will lead to a significant spike in prices.

This week investors will be watching for signs on how the next phase of ECB monetary easing will look like. European bond and equity markets have already been moving on assumptions of a rate cut and more Quantitative Easing (QE). If a rate cut doesn’t come on Thursday, expect ECB Chief Mario Draghi to provide guidance on when and how easing will take place. Any disappointment from the ECB will likely lead to a sell-off in Eurozone bonds and steep rally in the Euro, however, I don’t think this is the base case scenario.

Earnings season is in full swing, Tech along with Industrial companies will likely make most of the headlines. This week may determine whether US corporates will enter an earning recession or have avoided it. Alphabet, Amazon, Facebook, and Twitter among other companies will all release their second-quarter results. Almost 30% of Corporate America have been citing the US-China trade tensions as a major headwind to their profitability and expect this number to increase with the second week of earnings announcement.