Earnings season is most directly related to equities, but the change in market sentiment typically does affect currency markets. Particularly large shifts in investor appetite around stocks and provide large moves in forex, as we have been seeing over the last week.
Up until Wednesday, the market moves have been largely driven by fear. Investors are worried about what will happen with tariffs. The concern is augmented by mixed messaging out of the White House in regards to what will happen with the tariffs. There had been considerable debate about whether they were intended as a “shock and awe” tactic to force negotiations, which would largely be appreciated by the market. Or whether there was a push to reorient trade on the basis of long-lasting tariffs, which could lead to a recession.
Gauging the Reaction
The boisterous market reaction after US President Donald Trump announced a 90-day pause on the “reciprocal” part of the tariffs suggest that markets are now convinced the tariffs are a negotiation tactic. But, still, a substantial amount of tariffs remain in effect, such as the global 10% that affects every country regardless of trade balance. The tariff on steel and aluminum is also being maintained (consequently also the EU’s retaliation), and the 90-day moratorium does not apply to Canada and Mexico.
Crucially, the ratcheting-up tariffs on China are not being paused. But markets seem to be of the opinion that they won’t go into practical effect, as the two countries will at some point in the near future reach a deal. It’s just a matter of who will blink first.
Time for a Reality Check
Earnings season is an opportunity for corporate executives to make the case for why their businesses will remain profitable. Traders will keenly look for what each company says about how the remaining tariffs will affect it. Overall, analysts are optimistic, expecting Q1 corporate earnings to rise by over 7.0%, and profits to increase 9.6% for the rest of the year.
Typically, companies affirm their guidance for the rest of the year during their first quarter earnings. So, if there is a major change in outlook, particularly if it’s to the downside, markets could react negatively even if the company has stellar earnings. Despite the recent euphoria in the markets, there still remains considerable uncertainty around tariffs.
The Fed In a Starring Role
The season starts with major US financial institutions reporting, which could set the stage for the markets, particularly forex. That’s because major banks are extremely sensitive to what the Fed will do. The consensus among economists is that the Fed has its hands tied. That’s because higher inflation means it can’t lower rates to help support the economy. And higher-risk, higher-valuation companies, like the big tech firms that led stock growth, rely on lower interest rates.
So, if the consensus is that the Fed will risk a bit of inflation to support the economy under the circumstances, then risk appetite could regain momentum. Banks don’t import goods, meaning they are not directly impacted by tariffs. If even they have a dour outlook at the start of earnings season, it could mean the recent gains in the market could fade.