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In the closing week of February, traders are poised to sustain the momentum of the AI-driven surge in the market, despite looming economic apprehensions and the imminent release of the Fed’s favored inflation metric. Here are four reasons why equity may run out of steam soon:
 

Valuation risk

Stocks concluded the week on a positive note, bolstered by Nvidia's exceptional earnings performance. The S&P 500 soared to unprecedented heights, propelled by Nvidia's remarkable ascent, which surged over 8% this week, with an astonishing 16% spike on Thursday alone, following its earnings outperformance. Nvidia, the pivotal player in the market, has surged by 59% this year.

Having that said, the valuation may be a little bit high even with the strong momentum at this moment, traders need to position some safe-haven assets like Yen or gold to hedge against the risk.
 

Inflation risk

For investors, this week reaffirms the legitimacy of the technological drive that has propelled the market for the past year, with many anticipating its continuation. However, concerns persist regarding the sustainability of these market frontrunners in the face of lingering economic and inflationary risks.

While betting against the current AI fervor seems daunting in the short term, indications point towards an enduring trend. Notably, US equities weren't the sole beneficiaries of Nvidia's success this week. Global markets also surged to record highs, with Japan's Nikkei 225 reaching unprecedented levels on Thursday for the first time since 1989, alongside Europe's Stoxx 600 and a rebound in the Chinese market. 
 

Yen may benefit in the near term

Many investors advocate diversifying portfolios amid record highs, favoring quality assets in alternative market segments or foreign exchange. While equities may witness a potential further ascent, a prudent strategy involves augmenting short-term FX positions, particularly hedging against risks with safer currencies. Japanese yen may be a choice after USD/JPY refuse to move too far above the 150 level. BOJ refuses to ease in the near term also gives the yen a boost.
 

Fed is not likely to ease in the coming months

The impending release of the Fed's preferred inflation gauge holds significant importance. Set for Thursday, this report gains heightened relevance following earlier-than-expected consumer and producer price index reports this month. A softer-than-anticipated reading in January's personal consumption expenditures may not impact the market significantly, whereas a stronger-than-expected outcome, indicating the absence of anomalies in CPI and PPI, could dampen equities and propel bond yields.

Investor apprehensions persist regarding persistent inflation, potentially anchoring the Fed to a prolonged higher-for-longer interest rate policy. Market sentiment, as reflected in the CME FedWatch Tool, suggests a mere 55% likelihood of a quarter percentage point rate cut by June, following expected holds in March and May.

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