• FX market in a stalemate ahead of crucial central bank decisions

• Wall Street takes a step back after bull run, tech earnings loom

• Oil ignores military strikes against Iran, awaits OPEC meeting 

FX traders brace for central bank updates

A massive week lies ahead for investors. Central bank decisions in the United States, Eurozone, and United Kingdom, earnings updates from several Wall Street tech giants, and a heavy dose of economic data releases that include the US employment report all have the capacity to inject volatility into global markets.

All roads lead back to the Fed, which will announce its rate decision on Wednesday. Inflation finally seems to be cooling and leading indicators suggest economic growth is losing steam, but the US labor market remains historically tight and financial conditions have loosened, keeping the risk of a second inflation wave on the table and complicating matters for policymakers.

Markets have fully priced in a 25 basis point rate increase, so the dollar's reaction will depend mostly on Powell’s commentary. One way to balance these risks would be to accompany the smaller rate hike with strict language, reminding investors that the tightening cycle is not done yet and pushing back against market pricing for rate cuts later this year. 

Meanwhile, the European Central Bank and the Bank of England are both expected to roll out bigger rate increases of 50 basis points, outpacing the Fed for the first time this cycle. There’s some doubt about whether the BoE will truly deliver, after the latest round of business surveys underscored UK recession risks, although Cable will also be driven by how stock markets perform.

Euphoric stocks take a breather

Turning to equity markets, a sense of euphoria has been the underlying theme so far this year. Wall Street indices led by the Nasdaq have charged higher, the VIX ‘fear gauge’ is trading at its calmest levels since the tightening cycle began, and spearheading this entire rally are the riskiest and lowest-quality names.

Meme stocks are back in fashion, alternative crypto coins have returned to life, and the market reeks of a gambling attitude similar to 2021 as extremely risky options with zero days to expiry are the latest hot trend.

Behind this euphoria lies a liquidity dump that has countered the effects of the Fed’s quantitative tightening process this year. Faced with another debt ceiling standoff, the US Treasury has been running down its cash buffer at the Fed, a process that essentially releases liquidity back into financial markets.

Therefore, the latest rally seems like a mirage enabled by a temporary liquidity injection, unusual options activity, and a squeeze on short positions. The S&P 500 is now trading at 18 times this year’s estimated earnings in a slowing growth environment, which leaves the market vulnerable to a selloff in case this week’s tech earnings or Fed meeting contain any surprises.

Oil shrugs off Iran strikes

In the commodity arena, oil prices are trading lower on Monday despite a new wave of tensions in the Middle East. A drone attack against military facilities in Iran has left the region in a state of unease, with a Wall Street Journal report suggesting that Israel was behind the strike.

Even though oil infrastructure does not appear to have sustained any damage, it is still strange to see energy markets so calm in the face of geopolitical tensions. Oil prices have been trading sideways for a couple of months now, as optimism around China’s reopening offset the gloom about slower growth in Europe and America. The next key event is the OPEC meeting that will begin tomorrow.

As for today, there isn’t much left on the economic calendar other than some second-tier data releases from the Eurozone. Most of the price action might come down to position adjustments and hedging ahead of the main events later this week.