Stock Traders Protest as Fed Officials Not Dovish Enough

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Stock Traders Protest as Fed Officials Not Dovish Enough

Major Moves

The value of the US dollar has been falling all month as traders prepare for the Federal Open Market Committee (FOMC) to lower interest rates twice in the second half of 2019, but the slide has intensified this week.

For a year, the US Dollar Index, which measures the value of the US dollar (USD) to a basket of currencies including the euro (EUR), British pound (GBP), Japanese yen (JPY), and Swiss franc (CHF), has been stabilizing in an upward-trending wedge. All of that came to an end this week as the index broke through uptrending support.

When a country’s central bank begins to shift toward a more accommodating monetary policy, the value of that country’s currency begins to fall in relation to other currencies. That seems to be the case in this case.

While the USD remains strong in comparison to where it was before to its meteoric climb in late 2014 and early 2015, this reversal may be beneficial to certain major multinational corporations that produce a significant amount of income abroad. When the value of the US dollar rises, businesses receive less bang for their buck from earnings earned abroad because the conversion rate works against them when they repatriate the funds back to the US. When the value of the USD falls, corporations earn more out of their foreign-generated revenues since the conversion rate favors them.

For example, if a corporation earns €1 million in profits in Europe at a EUR/USD exchange rate of 1.25 (as it did in early 2018), the company may claim $1.25 million in earnings when it repatriates the money since €1 equals $1.25. However, if a corporation earns €1 million in profits in Europe and the EUR/USD exchange rate is 1.10 (as it was in May), the company may only claim $1.10 million in earnings when the money is repatriated since €1 is only worth $1.10.

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Companies with significant international income, such as eBay Inc. (EBAY), McDonald’s Corporation (MCD), and Mondelez International, Inc. (MDLZ), could profit if the USD continues to fall.

S&P 500 vs. Russell 2000

The S&P 500 continued its decline from its recent all-time high as two FOMC members disappointed markets with their remarks on monetary policy today.

The disappointment began when James Bullard, president of the Federal Reserve Bank of St. Louis, startled Wall Street by downplaying the possibility of the FOMC cutting the Federal Funds rate by 50 basis points (0.50%) at its July meeting, which had been gaining traction. According to the CME FedWatch Tool, traders had priced in a 42.6% possibility of a 50-basis-point decrease in July as of yesterday. Traders have reduced those odds to 35.4% as of today.

Not to be outdone, Fed Chair Jerome Powell put a damper on interest-rate speculation by adding, “we are aware that monetary policy should not overreact to any given data point or short-term movement in mood.” While this comment does not rule out the possibility of further rate reduction, it was enough to cause a wave of profit taking today.

Traders are already anxious about rising tensions between the United States and Iran, and that President Trump’s meeting with President Xi Jinping at the G-20 Summit would not end the two nations’ trade war. Remove the euphoric expectation that the FOMC would ride in and rescue the day with significant rate reduction, and you have the possibility for Wall Street to continue selling.

Read more:

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How US Stock Prices Relate to the US Dollar’s Value

How US Firms Benefit When the Dollar Falls

Risk Indicators – TNX

Following a brief uptick last Friday, the 10-year Treasury yield (TNX) has resumed its downward trend. The TNX has closed below 2% for the first time since November 8, 2016. This is another evidence that traders are predicting not just a protracted era of low interest rates, but also the possibility of an economic slowdown and a stock market fall.

Traders prefer to purchase Treasuries, which raises Treasury prices and lowers Treasury yields, when the FOMC is expected to decrease rates and when stock prices are expected to fall. At this point, it’s almost a given certainty that the FOMC will lower interest rates during the next six months. The only remaining question is how much.

What we don’t know is what will happen to the US economy and the S&P 500 within the same time period. It’s difficult to complain about the index reaching fresh all-time highs, but traders are nonetheless concerned about a possible drop. The TNX is expected to stay low for the foreseeable future.

Read more:

Understanding the Different Types of Bond Yields

How Can Bond Yields Influence the Stock Market?

Understanding Bond Prices and Yields

Bottom Line – Profit Taking

With so much uncertainty on Wall Street, I wouldn’t be shocked to see more profit taking as we approach the Fourth of July holiday. However, it is crucial to realize that profit taking does not always imply a fresh negative slump. I anticipate more consolidation.

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