Dollar Strength, Fed Funds Futures, Q1 Earnings Season

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Dollar Strength, Fed Funds Futures, Q1 Earnings Season

Three “Data” items today:

Topic #1: The dollar’s continued strength versus the euro, yen, and pound. Consider the following charts:

First, here is the US dollar-euro exchange rate over the last 5 years (CNBC.com chart). At 1.09 to the dollar today, the euro is almost back to the February – May lows around the 2020 pandemic crisis. The euro/$ low for 2022 is 1.085, set on March 7th, just one day before the S&P 500 low for the year. As you can just make out on the far right side of the chart, the euro seems set on at least testing those 2022 lows this week.

Now, here is the 5-year chart of the Japanese yen/US dollar exchange rate. We discussed this currency cross last week, but since then the yen has continued to weaken and it made a fresh low versus the dollar this past Friday (124/$). It is now down 8 percent on the year and 20 pct below best levels of the last half decade (end of 2021, 103/$).

Last up is the British pound/US dollar exchange rate. Like the euro, it is sitting very close to its 2022 lows, at 1.300/$ on March 14th (the day of the S&P retest of its March 8th lows) versus 1.303/$ now. This 5-year chart shows that the pound is much more in the middle of its longer-run range, rather than at the extremes we saw with the euro and yen. (Note: the Brexit national referendum was held on June 23rd, 2016, and the pound fell to 1.32/$ in the days after; we are below those levels today.)

Takeaway: while it is easy to see why the euro, yen and pound are weakening versus the dollar right now given interest rate differentials and Fed policy guidance, March’s day-to-day correlations between the greenback and the S&P 500 is notable. The yen seems on a one-way trip lower, at least until Japanese policymakers either intervene in currency markets or the Bank of Japan lets long term rates rise further. The euro and pound trade poorly, and the week ahead will show if they can hold their 2022 lows or will move lower. Given how their last downdraft correlated to weakness in US stocks, we will be keeping tabs on their movements.

#2: Recent changes in Fed Funds Futures markets, which give market-based probabilities for 2022 FOMC policy scenarios:

  • Futures put 79 percent odds of the Fed moving by 50 basis points at the next meeting, scheduled for May 4th. A week/month ago those odds were 69/38 percent, respectively.
  • The probabilities of a 50/75 bp hike at the June 15th meeting are 53/35 percent, respectively. A week/month ago, they were 59/19 and 12/0, respectively. A 75 basis point hike in June is not yet the Future’s market base case, but 1:3 odds say it is a distinct possibility.
  • As for where Fed Funds may end the year, Futures are pricing 2.50 – 2.75 percent as the current modal (highest probability) outcome. This range was also last week’s modal estimate. Futures have been putting a higher probability of 2.75 – 3.00 percent Fed Funds by year end over the last week, however, with 31 percent now versus 25 percent a week ago.

Takeaway: Fed Funds Futures continue to price in ever-more aggressive central bank policy. It is hard to see equity or bond markets truly stabilizing until Futures stop discounting more/larger Fed rate hikes on a regular basis.

#3: Q1 US corporate earnings season, which begins this week, has only one job – beat Q4 2021. The chart below, courtesy of FactSet, explains why that is of critical importance:

  • The entire S&P 500 rally off the March 2020 lows was built on a remarkable reset in US corporate earnings power. Prior to the pandemic, S&P earnings averaged $40/share per quarter in 2018 and 2019. Q4 2021 index earnings were $55/share, 38 percent higher than before the pandemic.
  • The S&P is up 33 percent on a price basis from pre-pandemic February 2020, right in line with the index’s 38 pct increase in earnings power then to now.
  • And then we get to Q1 2022, where Wall Street analysts currently expect $51.75/share. We all know analysts set up their estimate so that companies can beat them by 5 – 6 percent, so the “real” estimate is $54 – $55/share. Yes, right in line with Q4 2021.
  • The problem now is that analysts expect future quarters to show further earnings growth. By Q4 2022, they expect the S&P to earn $60/share. That is another 9 percent on top of what is already record high index earnings.

Takeaway: Q1 2022 corporate earnings need to come in better than the usual 5-6 percent beat percentages to reassure investors that the path to $60/share in quarterly earnings is still viable. US corporate earnings have been the engine powering US stocks to new highs over the last 2 years. Q1 financial reports will tell us how much is left in the tank.

Sources:

CME FedWatch: https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html

FactSet Earnings Insight report: https://advantage.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_040822.pdf