Hirst: Fed Tightening May Be Defining Factor for Equities and the Dollar

Your Real Vision Daily Briefing for July 15, 2020

Senior editor Ash Bennington joins managing editor Roger Hirst to discuss the latest developments in markets and macro.

  • Emerging markets have had the longest sustained outperformance versus the S&P since the end of 2018, which is commensurate with a weaker dollar.
  • The momentum of U.S. equity markets is slowing due to Fed balance sheet tightening.
  • Recent earnings reports for some of the U.S.’s large banks reveal the bifurcation of the real economy and financial markets.

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We’re seeing a divergence of large-cap stock indexes and small-cap stock indexes in the U.S., but what’s even more interesting is the how the U.S. is performing versus emerging markets, Roger Hirst told Real Vision during today’s Daily Briefing.

Emerging markets have had the longest sustained outperformance versus the S&P since the end of 2018, which is commensurate with a weaker dollar and a signal of rotation, Hirst said. He thinks that the market is still struggling for direction; there could be another breakout because there’s still ample liquidity and very loose financial conditions, or we may just run out of momentum. Either way, Hirst said that investors should be aware that there are some warning signs on the horizon.

Hirst also discussed how the dollar appears to be rolling over and said the dollar index is looking like we could see it move back to the bottom of the range that’s been in place the last few years. What happens with the European relief package and the 7-year EU budget this week could be significant, he said, given that the dollar index is 57% euro.

At this stage, it doesn’t necessarily warrant caution, but it is something to be aware of, Hirst said. He noted that the dollar has been weakening ever since the Fed has been tightening its balance sheet. It has also slowed the momentum of the S&P.

“The good news is equities haven’t sold off but we’ve lost momentum,” he said. “How far the Fed will go in tightening its balance sheet may be the defining factor for both the equity market and the dollar at this stage.”

Hirst also discussed the recent earnings reports from U.S. banks and what they may portend for the future. He said the key element to be aware of is the clear bifurcation between trading houses and the commercial element.

Better earnings from investment banks are expected during a period of volatility like we’ve seen, he said, but non-investment banks have more exposure to the real economy.

For example, Hirst pointed to Wells Fargo, which holds about $180B of commercial real estate. That’s clearly going to be a heavy burden going forward, and a lot of commercial banks will likely be in a similar position, he said.