S&P 500 Braces for Powell Testimony, Key PMI Data, EU Summit

[MongiIG]

Jun 20, 2022 | DailyFX
Dimitri Zabelin, Analyst

S&P 500 OUTLOOK, POWELL TESTIMONY, EU SUMMIT, COLOMBIAN ELECTION RUNOFF - TALKING POINTS

• S&P 500 volatility could rise on geopolitical risks in Europe ahead of the EU summit
• Price oscillations likely to be amplified by Fed Chairman Jerome Powell testimonies
• French equities, Colombian Peso may rise as market-friendly outcomes appear likely

 

POWELL TESTIMONY
After raising interest rates by 75 basis points for the first time since 1994, Fed Chair Jerome Powell will testify in front of the US Senate Banking Committee and the House Committee on Financial Services. The central bank reiterated its “unconditional” commitment to price stability last week, suggesting that aggressive tightening will likely continue.

Mr. Powell said the central bank could raise rates by 50 or 75 basis points in July, depending on inflation and economic activity. An unintended risk Fed tightening could have on the financial system is the pressure it would put on debt instruments (leveraged loans, collateralized debt obligations [CLOs]) that were aggressively issued under the outgoing ultra-easy credit regime.

According to US bank regulators, many leveraged loans possess weak structures. They “reflect layered risks that include some combination of high leverage, aggressive repayment assumptions, weak covenants, or terms that allow borrowers to increase debt, including draws on incremental facilities”.

Consequently, higher interest rates combined with the prospect of slower economic activity mean firms with low credit ratings, steeper debt payments, and lower profits margins become highly at risk of default. As it stands, the leveraged loan index is trading at its lowest point since November 2020.

Reverberations in this multi-trillion-dollar market will almost certainly spill over across asset classes. In the case of rising defaults, the US Dollar and Japanese Yen would likely rise the most against more cycle-sensitive currencies like the Australian and New Zealand Dollars. Consequently, Fed policy - and key economic data - will be crucial to monitor.