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S&P 500 Rally Continues Despite Rate Jitters and US Dollar Strength

by SuperiorInvest

Last Friday's US inflation revisions were negligible and hinted that US inflation was about the same as late last year. Consumer prices increased 3.3% in the last three months of the year in the US; The latter was good news for everyone who was eager to see the Federal Reserve (Fed) finally start cutting interest rates sometime in the first half of this year. But alas, the bond (which reacts best to rate expectations) rose on Friday and is gently piercing above the high of the descending channel from October until now, and is flirting with the 4.20% level again despite of last week's strong bond auctions in the US. Activity in Fed funds futures offers less than a 20% chance of the first rate cut in March, while the probability of a May cut has fallen to around 63%, from more than 90% before the successful jobs report published in January.

In theory, when yields go down, stock valuations go up. But valuations, which are heavily influenced by Big Tech stocks, have decoupled from returns a few weeks ago. The 2-year yield bottomed in mid-January on the realization that Fed taper expectations had come forward, but the S&P 500 continued to race from record to record and rose for the 14th. week for the last 15 weeks, something that apparently hasn't happened since 1972. The index closed last week above the psychological mark of 5000. On the other hand, it recorded its 11th ATH this year. Strong U.S. economic data that continues to challenge the theory that the economy should slow when rates are raised, strong earnings from big U.S. companies (especially tech companies that continue to ride AI optimism), and slowing inflation are the main drivers of optimism. The decoupling is also true for small cap stocks. But the more S&P 500 stocks extend their gains to new highs, the harder it becomes to find new buyers, as many investors are already on board, perhaps waiting for a drop to expand their position, in a market that forgot the formation of a dip

On the other hand, CFTC data shows that net speculative positions are building up against the S&P 500. It could mean two things. One: there are more and more investors who are betting on a correction at current levels. And two, if the correction doesn't happen, these bets against the S&P 500 could reverse and help the S&P 500 extend its gains. The most reasonable scenario is a correction, but hey, the rally could last as long as investors are willing to buy.

This week, the focus will be on the latest CPI updates. Headline inflation is expected to fall below 3% from 3.4% a month earlier and core inflation is expected to decline from 3.9% to 3.8%. If there are no big surprises in these inflation figures, there is no reason to think that the Federal Reserve is going to spoil the market mood. If that is the case, the US dollar should continue to find resistance near its 100-day moving average and allow its peers to regain some ground. It could retest its 200-day moving average near 1.0830, could remain bid up to the 150 level and the Cable could consolidate above 1.26 until Wednesday's British inflation data. Remember, inflation in Britain had surprised higher at the last meeting. The Bank of England reminded investors that its fight against inflation is not over yet and some MPC members even voted to raise rates at their last meeting. Thus, the market expects a cut of only 75 basis points this year from the Bank of England (BoE), less than half of what was expected at the beginning of this year.

Waiting for monthly oil reports

The positive trend since the beginning of this year is becoming clearer, although the top remains difficult to break near the $80 per barrel level. Still, US crude oil extended its gains above $77 per barrel on Friday and is bullish this morning, in a very slow Asian session with many Asian markets closed for the Chinese New Year holidays. Israel, rejecting Hamas's call for a ceasefire, supported the latest bullish move last week.

This week, OPEC and the IEA will publish their monthly report on Tuesday and Thursday, respectively. Attention will be paid to how they will revise their demand outlook in reaction to global developments. On the one hand, the strength of the US economy and Chinese stimulus measures are positive for demand dynamics and should support oil prices beyond geopolitical tensions. On the other hand, the significant decline in expectations of global interest rate cuts weighs on the outlook for global demand. One thing is certain: OPEC will continue to fight to keep oil prices sustained until the latest drop. The problem is that Biden's United States is pumping a record amount of oil to counter OPEC's much-needed price increases.

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