Economic data may have unexpected surprises, and the FOMC meeting could be beneficial for the market to continue rising.
The U.S. Treasury Department mentioned six major reasons for the depreciation of Q1 dollar assets (stocks, currencies, bonds) in a report released last week (see Figure 1). Even though I believe three of these six factors are no longer an issue, the other two are what we need to pay attention to: the state of the U.S. economy and fiscal situation, the attractiveness of U.S. Treasuries as a safe-haven asset, and the situation regarding the trade war. To reiterate, the trade war has a short-term impact of stagflation, which will lead market expectations towards rising interest rates (inflation rise) and risk aversion (asset price decline). Recently, China's softened stance on the trade war and the first trade agreement will contribute to the market starting to improve, and I believe that economic data in May may bring unexpected surprises (going against those who are pessimistic about the economy; in fact, the market performed well last week)!
The recently released Atlanta Fed GDP forecast is higher than the mainstream consensus (see Figure 2). The main reason for Q1 GDP of -0.3% is affected by stockpiling, while actual GDP performance is robust. The employment data in April was better than expected, leading the market to lower the probability of interest rate cuts this week (see Figure 3). Currently, the probability of a 25 basis point rate cut in June is only 33.95% (with a 78% probability for a rate cut in July). However, I personally believe that the economic data in May might raise the probability of a rate cut again, especially if the CPI data drops significantly (see notes from 4/14 to 4/20), while the unemployment rate remains high, which would trigger more aggressive rate cut expectations.
Regarding inflation expectations, according to Figure 4, FWISUS55 shows that the market's medium-term inflation expectations have not yet further declined, and it is close to FED5YEAR, indicating that the market expects the Federal Reserve's long-term interest rates will eventually fall back to around 2.25%. The market is currently in a phase of unstable structural inflation reassessment (transition period), and once the May inflation data declines or the Federal Reserve turns dovish, these situations will reverse. In simple terms, short-term inflation issues will ease, while concerns about unemployment will rise, which will prompt the Federal Reserve to begin to adopt a dovish stance. Pay attention to the PMI and FOMC next week.
Next, let's take a look at the overall market liquidity situation. See Figure 5, BFCIUS Bloomberg Financial Conditions Index has rapidly rebounded since early April (close to tariff day levels), indicating that the financial environment is beginning to improve and market risk appetite is warming up. Both RRP and TGA started to decline after rising together (as indicated by the yellow circle), with funds stabilizing and flowing back into the market. Overall, the financial environment leans towards 'neutral easing', as previously mentioned, to truly unleash the market, the U.S. needs to start releasing liquidity (waiting for the Federal Reserve). The sideways movement of SOFR is a signal that the easing cycle has not yet begun.
Returning to the cryptocurrency market, as previously mentioned, there is a chance to continue rising after the FOMC meeting following a correction in early May. In MSTR's Q1 report released on Thursday, it mentioned upgrading the original plan of 42 to 42 + 42, with plans to refinance $56.7 billion for investment before the end of 2027... (see Figure 6) 🤯. Recently, I have seen more and more listed companies learning from the MSTR model to establish cryptocurrency reserves, and the trend of institutional adoption is still far from a frenzy stage 🐂.
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