Get our take on what to expect from the ECB meeting, why the euro may struggle to reach $1.20 at the start of this week, and why stocks should recover, eventually.
The end of last week saw a surge in volatility and a dramatic sell off in the equity market, particularly in US -listed technology shares. To highlight the extent of the downward pressure on tech, after leading the S&P 500 for most of the recovery rally since March, Apple sunk 7% last week, while the S&P 500 fell just over 3%. There was a similar fate for other stocks including Amazon and the Nasdaq darling Tesla, which fell 12% over the week. Next week’s tech stock performance will be dependent on a few factors, which we will explore in more detail below, but as we start the week, volatility remains elevated and an attempt by the Nasdaq 100 at a recovery late on Friday withered away by the time the markets closed. Right now, the market is turning against tech, and we believe that this may continue as we start a fresh week.
What to watch in the ECB meeting
The other main event this week is the ECB meeting on Thursday. The decision will be announced at 1245 BST, with the statement and press conference at 1330 BST. No big policy changes are expected at this meeting, which makes the ECB Press conference, headed by ECB President Christine Lagarde the most important part of this central bank meeting. Investors will be looking for two things: 1, will Lagarde talk about the strength of the euro, and 2, will the ECB lower its inflation forecast, on Friday both Germany and Spain are expected to report that they have fallen into deflation in August.
Will the ECB. Dare to talk down the euro?
The euro has been one of the best performing currencies in the G10 this year, and it is close to its highest level since April 2018. The euro has surged as the dollar has declined in recent months’; however, this is becoming problematic for some members of the ECB. The bank’s chief economist mentioned that the euro/ dollar exchange rate does matter. However, trying to talk down the euro is a risky strategy as the market could test the ECB’s desire for a weaker currency, by pushing it even higher and getting them to take more drastic action in an attempt to bring about a weaker euro. This may require more asset purchases or further interest rate cuts, something that we don’t think that the ECB is willing to do at this stage. Instead, the ECB could focus on the fact that the euro is rallying because of the EUR 750bn rescue fund agreed by the European Council in July. Lagarde may also keep the pressure on EU leaders by reiterating that the success of the economic recovery for the currency bloc will be dependent on action from the leaders, and not from the central bank.
Watch stocks to see if EUR/USD makes it to $1.20
Thus, we believe that the ECB meeting could be fairly neutral for the euro, and instead the ECB will reiterate that it is ready to do more to support the economic recovery if necessary, without specifying what it may actually do. Looking at the euro, it is worth noting that the dollar index rose by nearly 1% last week as US stocks sold off, and EUR/USD fell 100 pips as traders experienced nerves ahead of $1.20. We believe that the next move for US stocks will be the biggest driver of the FX market and the euro at the start of this week. If stocks continue to sell off then this could give the dollar a chance to recover further, and drive EUR/USD back below $1.18, however, if stocks move higher then the euro may well test that $1.20 level.
Why US stocks may have further to fall, for now
Returning to US stocks, we think that in the short term there could be further downside, in particular for tech stocks, due to a couple of reasons. Firstly, the Nasdaq is still up more than 21% for the year so far, and although the sell-off may seem large, the 7% drop for Apple doesn’t take away from the fact that it is still up more than 60% for the year. Added to this, retail traders are thought to have been big buyers of Apple after last week’s stock split, which made Apple shares cheaper for investors to buy. However, these traders will be the most exposed to a drop in price, thus we could see more retail liquidation of tech stocks at the start of a new week. Secondly, the market may react badly to the news that Tesla was not included in the latest S&P 500 reshuffle. The index did not give any reason for failing to omit Tesla; however, it may be due to its reliance on selling regulatory credits to other car makers, which has generated $782mn in the first half of this year and had a major impact on its earnings. Thus, the S&P board may be questioning whether Tesla can rely on its own business: designing, manufacturing and selling electric vehicles, to generate future profits. If this news plants a seed of doubt in investors’ minds then Tesla’s share price could remain vulnerable this week, especially since its share price has risen fivefold in 2020.
Stocks – a safe bet in the long term
While we think there could be more downside for US stocks in the short term, in the long term we remain constructive and think that this is a much-needed pullback. Stocks remain more attractive than bonds, due to the record low bond yields on most “safe” assets like government debt. Added to this, US inflation data released on Friday is expected to show that price increases continued to moderate in August, with monthly prices rising 0.3%, vs a 0.6% increase for July. If weak inflation growth is confirmed then it makes it likely that US interest rates will remain lower for longer, which is good news for stocks and other risky assets.
Overall, the early signs at the start of the week is that stocks could remain under pressure and the dollar recovery has further to go. At the Tokyo open the dollar index is testing 93.00. This could suggest that stocks will open lower later on Monday.