Stocks: Weakness persists amid central bank tightening

Choppy price action continues to dominate markets as investors weigh the impact of central bank policy tightening on inflation and economic growth. While some indices have bounced off their lows again, the overall price action continues to remain choppy and inside larger downward trends for many. We are still in a bear market and with central banks ending QE and reducing their balance sheets, the good days of the stock markets may well be behind us. Keep your seat belts fastened because there will be more turbulence ahead, as central banks are forced to withdraw support.

On Monday, as we had suspected, stocks were once again unable to hold onto their gains as the major indices sold off their highs with rising bond yields and appreciating US dollar weighing on risk appetite. Sentiment was and remain driven almost entirely by fears over inflation or stagflation, as evidenced by rising bond yields resulting in stock market weakness. Although a touch weaker today, the 10-year US Treasury yield remains above 3%, as investors await further sharp interest rate hikes from the Fed. Other central banks are tightening their belts – some aggressively in the case of the RBA for example, hiking by 50 basis points overnight, and others less so. All central banks are in the same battle: to tame inflation and this is making the market nervous. The ECB is up next on Thursday and there are fears that it too is far behind the curve, which means it will have to adapt a steeper path to tightening policy, something which could tip the already-struggling Eurozone into a recession.

German factory orders fell for 3^rd month

Indeed, we saw further weakness from German data this morning in the form of factory orders, adding to a long list of downbeat macro pointers of late, amid ongoing inflation squeeze. Orders unexpectedly fell 2.7% on the month in April, disappointing expectations of a small rise and marking the third straight monthly decline. With China re-opening, hopefully demand for German and European goods will improve moving forward. But owing to supply chain woes, soaring energy prices and falling consumer confidence in many regions of the world, there are plenty of reasons to remain pessimistic. A recession is highly likely for Germany and the European Central Bank might be unable to do anything about it.

Central bank support no longer there

Unlike before, equity investors will not have the support of the Fed to prop up the stock markets. That’s why this general downward trajectory in stock prices has lasted longer than most of the previous episodes. I expect this trend to continue now that the Fed has started to shrink its balance sheet by $95 billion or so every month for the foreseeable future. This means that any piece of good news will likely be treated as bad news for stocks, since the Fed’s moves will be data-driven. Meanwhile, the ECB is set to exit negative interest rates in next few months. On Thursday, Christine Lagarde and her ECB colleagues will announce an end to bond purchases and prepare the markets for what is to come later in the summer. It will therefore formally join global peers tightening monetary policy in the face of hot inflation. In July, the ECB is seen lifting the deposit rate from the current -0.5% by a quarter-point. Elsewhere, central banks from Australia to Canada have hiked their interest rates by 50 basis points.

Against a backdrop of fast interest rate hikes, this is far from being an ideal environment for stock markets.

Euro Stoxx False break?

The Euro Stoxx 50 index may have broken its bearish trend line, but this could be a false breakout because we haven’t seen any upside follow-through. If the index reclaims the broken trend line, then this would be a strong bearish signal, which could result in renewed technical selling pressure:

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