Why global markets are in for more pain during the summer

The US dollar has continued to strengthen this month, paring all of its losses from April, at the time of writing.

The greenback's move in May has been rather curious and could have ominous undertones for financial markets as we approach the summer months.

Let us have a look at the developments in May thus far to provide a bit of a backdrop.

On May 3, the Federal Reserve delivered a rate increase of 0.25 per cent, taking the overall lending rate to a target range of 5 per cent to 5.25 per cent, its highest levels since August 2007.

While the increase was expected, it was the post-meeting statement that drew more interest.

The sentence “some additional policy firming may be appropriate”, which had been a part of all previous statements until May’s meeting, was removed. This would suggest that the current rate increase cycle could come to an end and, ultimately, open the door to a period of rate pauses.

The perceived dovishness of the Fed resulted in markets rallying against the dollar.

On May 5, the US non-farm payrolls report showed a hotter-than-expected jobs market. On the headline print, 253,000 new jobs were added. This was well above the expected 180,000.

Unemployment dropped to 3.4 per cent while hourly earnings — a metric of inflation measurement — ticked higher.

And last week, the longer term inflation expectations showed signs of increasing. This was despite overall consumer price inflation either being in line with expectations (unchanged) or slightly lower (year-on-year CPI print came in at 4.9 per cent, down from a previous reading of 5 per cent).

The Michigan consumer survey showed an increase to 3.2 per cent, from an expected 2.9 per cent.

This was followed by Minneapolis Fed president Neel Kashkari telling markets that “inflation is coming down, but so far it’s been pretty persistent — that means we are going to have to keep at it for an extended period of time”.

This triggered a dollar rally and the index is now up 0.81 per cent on the month.

It seems like we have made no headwind on the key theme of 2023 so far — and will need to continue to rely on short-term data points and comments from Fed speakers to gauge the regulator’s internal thinking.

By the time this column goes to print, a host of Fed officials would have spoken this week and their comments will trigger reactions in risk sentiment.

The most recent dollar move signals that markets are not out of the woods yet and we could be in for a period of more pain through the summer months.

This would mean stock markets and higher yielding currencies would fall against the dollar, while US yields would increase.

The recent data (US jobs report and Michigan survey) shows that inflation concerns are not behind us and Fed officials could leave the door open to dollar appreciation in the weeks and months ahead.

Although the US debt ceiling deadline falls on June 1 — with political posturing expected to cause it to drag on until the final hours of May — we will see a resolution, which would see the ceiling increase by $1.5 trillion and the government avoid a default.

The ceiling will inevitably be raised but it will create some liquidity concerns through the coming months.

While the Fed will bankroll a portion of the budget to the government, the remainder would be provided by the US Treasury.

For the Treasury to do this, they would need to raise funds through bond issuances, which would drain liquidity in other markets (such as equities and other risky assets, while causing bond yields to increase in the summer months).

This means that we should be primed for more corrections in US equities in the months ahead.

If you are executing long positions in your favourite stocks, perhaps a wait-and-watch approach would prove wise.

Finally, gold continues to provide short-term opportunities. The upside of my previous range at $2,000 was comprehensively tested and we can now see it capped at $2,050 levels.

The lower support level of $1,970 cited last time could be properly tested based on my dollar forecasts.

Gaurav Kashyap is risk manager at Equiti Securities Currencies Brokers. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti Securities Currencies Brokers