Are Investors Ready to Hedge Their Bets on Wall Street?

What Is Driving Negative Sentiment?

A torrent of macroeconomic data has filtered through markets in recent weeks. Much of the current volatility is attributed to the loss of confidence in the ‘Trump Trade’ phenomenon. Positive economic data releases include a declining unemployment rate, currently at 4.3%, and bullish sentiment with soft data in the form of consumer and business sentiment. But it’s the hard-economic data that appears to be troubling investors and traders, and driving speculators to short positions on many key sectors.

Many investors are looking to hedge their positions in financial markets, preferring to steer clear of the firebrand rhetoric of populist leaders like Donald Trump, and focus instead on market fundamentals. Despite the lack of confidence in President Trump’s ability to get anything passed, investors remain largely optimistic about the country’s financial prospects. Fundamentally, the US economy is robust and growing.

The recent GDP growth figure of 1.20% is underwhelming, but is attributed to the warmer weather that decreased expenditure on utilities. Consumer spending has also been hampered by increasing inflation in the US economy, while real wages have not increased. Another factor which helped to stifle spending in Q1 2017 was the government’s tax refund delays. Nonetheless, Q2 2017 projections are expected to be robust and this will likely reverse the current trends we have seen.

What Impact Will the Fed Have on Economic Activity?

Janet Yellen and the FOMC are unlikely to be swayed too much by the trickle of weak economic data. The Fed takes a broad-based view of the markets and that is certainly bullish. Unemployment remains at near historic low levels at just 4.3%. Further, inflation is steadily rising towards the 2% objective. While price stability and full employment are the overarching objectives of the Federal Reserve Bank, it can intervene with monetary policy measures designed to stabilize the US economy.

Currency traders have been particularly hard at work what with the UK general elections, French parliamentary elections and Jim Comey’s testimony to the Senate intelligence committee. Currency traders are quick to pounce on any negative sentiment in the economy, by shorting volatile currencies in favour of safe-haven currencies like the JPY, or the EUR.

In the absence of fiscal policy stimulus by the Trump administration, the Fed has it within its purview to independently assess the state of the US economy with its 12-member FOMC board. Currently the probability of a June 14 rate hike is around 99%. This means that the federal funds rate is likely to increase by 25 basis points in June, raising the interest rate in the region of 1.00% – 1.25%.

This will boost industry profits in the banking and financial arena, but add additional pressures to the personal disposable incomes of US households with lines of credit. It will be interesting to note the impact of a Fed rate hike on the greenback, given the fact that most of the change has already been priced into equities and currency markets.

From Monetary Easing to Quantitative Tightening: A Fed Reversal

We have already seen multiple rate hikes since the Fed began to taper quantitative easing, in favour of quantitative tightening measures. The USD has strengthened dramatically in that time, and this has led to a weakening of emerging market currencies such as the South African rand, Brazilian real, Mexican peso and others. In 2017 for the year to date, the US dollar index has shown a depreciation of around 5%.

This is due to the pressures that President Trump is facing trying to get his work to pass through Congress. On Friday, 9 June, there was a major selloff of big-name tech stocks like Google (GOOGL), Apple (AAPL), Amazon (AMZN), Netflix (NFLX) and others. However, sentiment remains bullish. Bank stocks like Bank of America Corporation (BAC) are on the rise, and rate hikes will certainly give plenty of momentum to the financial sector.