Wall Street faces double test as Fed decision and Microsoft, Alphabet earnings loom

What happened

Wall Street enjoyed a bit of a breather in overnight trading, as the S&P 500 gained by 0.6% and Nasdaq closed higher by 1.2%. This rebound, following two weeks of declines, was largely driven by big tech names. However, the breadth of the move was not entirely convincing, with most stocks in the S&P 500 actually closing lower, raising concerns about overall market health.

Why it matters

This week is pivotal for global markets, with two major events on the horizon: the Federal Reserve's (Fed) monetary policy decision and the release of quarterly earnings from tech giants like Microsoft and Alphabet. While the Fed is widely expected to keep interest rates unchanged, all eyes will be on the Fed Chair's press conference for signals on future policy, particularly concerning December. With Treasury yields hovering near 5%, the market is highly sensitive to any indication that the Fed is becoming more uncomfortable with the inflation outlook.

Furthermore, the earnings reports from Big Tech are highly anticipated. For Microsoft, key metrics will include AI growth performance, spending commitments, Azure expansion, and cloud margins. Alphabet will face similar scrutiny regarding Google Cloud performance, AI monetization, and infrastructure spending. The ability of these companies to demonstrate that their substantial AI investments are translating into sustainable earnings growth will be crucial to justify current valuations.

Market impact

Interest rates and bonds: A more hawkish Fed stance, suggesting inflation concerns, could put upward pressure on Treasury yields. Conversely, disappointing tech earnings, particularly regarding AI spending, could reignite risk aversion, potentially leading to a simultaneous fall in both yields and stocks.

Dollar and currency: A more hawkish Fed typically strengthens the dollar, increasing pressure on emerging market currencies like the Brazilian real. Global risk aversion can also boost the dollar as a safe-haven asset.

Equities: The stock market, especially the tech sector, is particularly vulnerable. A hawkish Fed and/or weak tech earnings could revive concerns over lofty valuations and higher borrowing costs, leading to further declines.

Commodities: The impact on commodities is less direct, but a global economic slowdown, signaled by weaker equity markets and inflation worries, could weigh on raw material demand.

Brazil: The Ibovespa and the Brazilian real are likely to be negatively affected by global risk aversion, a stronger dollar, and potential pressure on local interest rates if the Fed signals persistent inflation.

What to watch

• Federal Reserve interest rate decision and Chair's press conference.
• Microsoft and Alphabet earnings reports and guidance.
• Upcoming US inflation and employment data.
• Movement of 10-year Treasury yields.

Scenarios

Base Case: The Fed maintains a cautious tone without drastic surprises. Tech earnings show resilience in AI, limiting significant market declines. The market remains volatile but avoids a sharp correction. Risk Case: The Fed adopts a more hawkish tone, heightening inflation and interest rate concerns. Tech earnings disappoint, especially regarding AI investment profitability. This could trigger strong risk aversion, leading to sharp drops in equities and pressure on emerging market currencies.

Original source: ForexLive (InvestingLive). For information only, not investment advice.