The dollar softens, equities extend losses, but...

The dollar softens, equities extend losses, but energy stocks gain on firmer oil

(Ipek Ozkardeskaya – Swissquote Bank Ltd)

The US dollar bounced lower, yesterday, following the weak economic data in the US, which showed that the new home slowed, and business contracted. The flash PMI figures showed that services in the US fell into a deeper contraction, while manufacturing slowed more than the market expectations. Both indices sank to the lowest levels since the first summer of the pandemic. Unfortunately, the weak data couldn’t revive the Federal Reserve (Fed) doves, yesterday.

US equity indices fell for the third day, as investors continued scaling back their long positions into the Jackson Hole meeting, where the Fed officials may not sound as dovish as many investors wish they would. The S&P500 slid another 0.22%, the Dow lost close to 0.50%, while Nasdaq was flat.

DAX gives half of summer gains as energy crisis deepen

The ugly PMI data also hammered the mood among the European stock traders, yesterday. The DAX is down more than 2% since the beginning of the week, and already gave back half of gains it recorded this summer. The softer euro could’ve normally given a boost to the European stocks, making them more affordable for foreign investors, but understandably, no one wants to stomach the risks of the deepening energy crisis in Europe. All the competitiveness that comes with the weaker euro is taken away by the increasing cost pressures due to the energy crisis, and the growing likelihood of a dark recession on the old continent.

And the euro is expected to dip further, and failure to stop the euro’s weakening will make the European imports, especially energy imports more expensive for the companies, and further boost inflation pressures. The European Central Bank (ECB) will have to tighten as much as it can, but of course, if the policy tightening can’t stop the euro’s depreciation, the Europeans will find themselves with rising inflation, rising interest rates and slowing economies.

FTSE benefits from solid exposure to energy, as crude rebounds

Situation in the British FTSE 100 is different, as the FTSE 100 has a solid exposure to energy and mining stocks, and having exposure to energy stocks is still one of the most interesting hedging options.

Oil stocks were boosted again yesterday, by firmer oil prices after crude rebounded past the $93 level on news that OPEC could cut production as they feel that the prices fell too much over the past two months. The FTSE slid along with its major European and US peers, yet BP added more than 2% and flirted with the 470p level yesterday.

Also, the latest API data came to support the oil and oil stock bulls, as the latest figures suggested another bigger-than-expected decline in the US oil inventories. The stockpiles fell more than 5 mio barrels last week, versus just 450’000-barrel fall expected by analysts.

We can now say that there are signs of a positive momentum building among the oil bulls despite the recession woes, and the first bullish target is the 200-DMA, which stands near the $96 per barrel, then the $100 psychological resistance.

The rebound in oil prices, along with the surge in nat gas futures could have two effects depending on the market’s actual mood. In one hand, the higher energy prices dampen the economic activity, and therefore could revive the Fed doves, and bring forward the idea that the Fed would soften its hand to support the economic growth. But on the other hand, the rebound in energy prices boost inflation and inflation expectations, and therefore could keep the Fed hawks alert, and underline the fact that the Fed will not soften its policy until inflation is meaningfully and sustainably down from the multi-decade high levels.

I believe that right now, the market mood suggests that the second option is most likely to be priced in: higher energy means higher inflation. Higher inflation means hawkish Fed, hawkish Fed means higher yields, and higher yields mean lower equity valuations.

Read EUR struggles for parity

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