Market sentiment firms as inventors eye a crucial Fed meeting (Daily analysis 22.09.2021)

Waiting for Chinese equity markets to resume trading after a four-day weekend may have been slightly like the nervousness of a naughty pupil when a parent takes a suspiciously long time to return from a school-parent meeting.

On Monday, the dollar reached highs in global markets, with the EUR/USD exchange rate touching 1.17 and rebounding slightly. Contracts on the most important stock indexes of developed markets also reached short-term lows at the beginning of the week.

Chinese worries (temporarily) go away

Evergrande has announced some sort of agreement with bondholders to avoid formal bankruptcy due to its inability to service payments scheduled for tomorrow. When and to what extent, and exactly how, the liabilities will be settled remains unknown. Of course, the problem is far from being solved and will probably reappear in the financial media headlines more than once.

For the time being, though, the issue is being swept under the carpet. The stabilisation of sentiment on stock exchanges and the corporate bond market was also supported by the People's Bank of China, which made a significant (up to 90 billion yuan) injection of liquidity into the financial sector. As a side note, we should add that the Chinese monetary authorities will probably continue with such ad hoc measures and will probably loosen the policy by, among other things, lowering the mandatory reserve ratio. As a result, Wednesday did not see the sharp downturn on Chinese mainland stock markets that investors had feared a few dozen hours ago. On the contrary: the sentiment across the Asia-Pacific region is stable. Even slight rallies of the most important indexes prevail. This allows market participants to shift their attention to a series of central bank meetings of developed economies, opened by the most important of them - the Federal Reserve.

Normalisation is not enough to lift the dollar

Strong economic growth, additionally boosted by a fiscal spending package worth over 8% of the US GDP, brings the US central bank closer to abandoning the instruments used during the crisis. They are already redundant - at the end of this year, the US economy will be larger than it would have been if it had grown at a pace consistent with the pre-pandemic trend. Retail sales are also several per cent higher than before the coronavirus outbreak. For the Federal Reserve, however, the labour market is particularly crucial.

Seventeen of the more than 22 million jobs lost during the pandemic have already been restored. This enables us to think about the gradual cutting of the stimulus to which the asset buy-back, carried out at a rate of at least 120 billion per month, can be graphically compared. The decision will probably be announced in Q4, but probably not yet today. We stand by our view that the dollar has most likely run out of room for strengthening from the start of the policy normalisation process. The Federal Reserve's plans have been widely known for months and have been thoroughly "digested" by investors. Comparisons with 2013, when a similar process caused strong shocks to stock markets, commodities and currency and bond prices, particularly severe for the world of emerging economies, are in our view unjustified. The Fed chief at the time, Ben Bernanke, did not prepare the markets for such a step and caused a shock that today can hardly be mentioned.

An opportunity for the dollar would be a possible rate hike at the end of 2022. For it to be possible at all, it is necessary to completely abandon bond purchases and instruments related to the property market. This process, known in the markets as tapering, will take at least six months. The recent signals from the economy, i.e. deceleration of inflation and slower labour market recovery, allow us to believe that the monetary authorities may want to remain as cautious as possible, i.e. the first possible date of the hike will be closer. Also, Fed Chairman Jerome Powell regularly cools down speculations on raising the cost of money. As a result, we maintain our negative perspective on the dollar. Highs are most likely behind us, and the EUR/USD pair should continue its course towards 1.20.