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When good news is bad news!

On Friday, U.S. employment figures were more than twice as high as expected. The unemployment rate also fell, albeit by only one decimal place. Still, U.S. stocks (as measured by the S&P 500 and Nasdaq) fell. Why should it be "bad" for U.S. companies that more Americans have jobs and disposable income?This is a recurring phenomenon in financial markets that can confound trading strategies. It is not unique to the United States. In Europe, indices have reacted differently, but that could change. Since there is a direct correlation between stocks, commodities and foreign exchange, this could also affect us currency traders.

Inhalt

  • What is actually going on here?

  • Equity markets are the most sensitive and currencies the least risky.

  • Data interpretation

What is actually going on here?

When central banks interfere in the economy, it changes the dynamics of the markets. Since most daily trading is done on margin, the cost of credit plays an important role in traders' decisions. And central banks try to influence the economy by manipulating the interest rate, which in turn manipulates financial markets. 

 

In general, central banks don't care about the short-term ups and downs of financial markets. They only care that price fluctuations are a sign of market liquidity, which could have broader economic implications. For example, if the Fed raises interest rates, it could make it more expensive to invest with margin. That, in turn, means that traders will buy and sell fewer stocks. That generally means the stock market will go down. The Fed doesn't really care about a slight drop in stock prices caused by less liquidity, because one reason for raising interest rates is to reduce the "excess" liquidity that could fuel inflation.

Equity markets are the most sensitive and currencies the least risky.

Inflation naturally means rising prices, and this also applies to the stock market. When stock prices rise above company valuations, prices become "inflated." Last year, companies reported disappointing earnings due to the COVID crisis, but stock prices rose. That means stock prices were inflated. 

 

The Fed's move to raise interest rates is the driving force behind lower stock prices, and that is what the Fed is trying to accomplish in the broader market. The stock market is simply the quickest to react.

Data interpretation

Better economic data is a sign that prices will continue to rise and that central banks will have to make more efforts to control inflation. The stock market is the first to react to this, which means that the good economic news ends up being bad news for the stock market. Even if the companies themselves have good news, such as Tesla's stock split, they could be pushed down by the broader market. In turn, currencies become stronger as the market becomes risk-off. 

 

As long as central banks are very active, markets are likely to have a reverse news pattern. Bad news leads to a more risk-averse market behavior and good news leads to a less risky behavior pattern. This could mean that trading strategies need to be reversed. However, traders will need to pay attention to when central banks pull back from their interventions and the usual "good news is good news" dynamic suddenly returns.

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When good news is bad news!

On Friday, U.S. employment figures were more than twice as high as expected. The unemployment rate also fell, albeit by only one decimal place. Still, U.S. stocks (as measured by the S&P 500 and Nasdaq) fell. Why should it be "bad" for U.S. companies that more Americans have jobs and disposable income?This is a recurring phenomenon in financial markets that can confound trading strategies. It is not unique to the United States. In Europe, indices have reacted differently, but that could change. Since there is a direct correlation between stocks, commodities and foreign exchange, this could also affect us currency traders.

inside-alternavest.article.writtenBy Massimo Di Santo.
Alternavest Partners GmbH Otto-Heilmann-Str. 17 82031 Gr├╝nwald

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