View: Fed expectations buoy stocks, better risk reward looks to be Gold
Reading through the Fed minutes is the boring part of those Wednesday evenings, far more entertaining is just how the market interprets what is often just subtle tweaks in the committee’s rhetoric, the August minutes being an excellent example of this. Headlines would lead us to believe that there has been a substantial shift in tone, inferring that the Fed has now primed the market for QE3 in September, snatching the comment that the Fed “will provide additional accommodation”. However, this overlooks the balance of the sentence which read “as needed to promote a stronger economic recovery and sustained improvement in labour market conditions in a context of price stability.” Together this is far from a definitive statement even if it sounds a little more accommodating than the minutes from the June meeting which itself is unsurprising given the data flow which completed the picture for (the softer) Q2.
Full report below…
View: Payrolls print is not an inflection point, open short 10-yr UST @ 2.05%
While most were absent Friday enjoying the Easter break those less fortunate were subject to a rather disappointing payrolls print with the headline missing the 200k consensus forecast by some 80k jobs and revisions were broadly flat (January -9k, February +15k). Hours worked also dropped back to 41.7 from 41.9 and earnings flat-lined, a further drag. The unemployment rate did drop to 8.2% from 8.3% but the participation rate was also a little weaker and therefore this improvement was not enough to offset the negative reaction the headline release brought.
Full report attached…
- ANALYSIS:US Mar Payrolls +120k, 8.2% Unemplymt-Only Fair News (forexlive.com)
View: Euro$ strip to continue to steepen, U2/U3 spread could double
While the shift in tone of the March FOMC statement may have been subtle the markets reaction has been fairly pronounced with yields shifting up across the curve. The adjustment is not too surprising, in fact it’s what we have been saying for many weeks, namely that the US economy is improving, led by the labour market, which the Fed is slowly starting to acknowledge. There was also some understated acceptance that there were fewer risks emanating from the external environment although these still posed ‘significant downside risks’, a tone that is overkill in our view. Of course the 2014 language remains and the programme to reinvest maturing paper into the longer-end of the curve continues, with just one dissenter in the form of Lacker.
Full report attached……
View: Fed’s stance a short-term headache for USD, impact on risk assets more prolonged
I started to write this note on Sunday which is a lesson as to why one should finish things at the time and not let them slide down the pile. At least with the FOMC now out of the way we can add some additional colour on how the DXY is trading and the implications this should have for markets overall both in the near-term and in the coming months. We identified the technical reversal signal seen in the dollar index in our weekly strategy, last weeks close leaving a nice bearish engulfing pattern on the chart which not only spanned the previous week’s trading but the one prior to that, adding some more force to this set up. Following the Fed last night we can add some further insight to this view and frame it more effectively in a macro context.
Full report attached below…..
- Weak $, many say risk on, I say self defense (ritholtz.com)
- Previewing Today’s Economic Events And FOMC Announcement (zerohedge.com)
View: DXY reaction to FOMC reinforces dollar bull credentials, S&P aiming for new lows
One of the downsides of trying to prep the market up for future policy decisions is that it limits the scope for a positive surprise. This has been happening throughout this cycle (although was also a regular feature during Greenspan’s incumbency), most noticeably ahead of QE2 and now it’s happening with the ‘twist’. Extending the duration of the Fed’s Treasury holdings by rolling down the strip was widely expected by the market, the only surprise in the outcome was that it appears the Fed wants to anchor rates right across the curve, extending buying right out to the 30-year rather than focus just on the 7-10-year sector (where most corporate bond issuance occurs) as most expected. So this was clearly the ‘surprise’ as reflected by the shift on the govvie strip (10/30’s spread fell 13bps vs. a 8bps move in the 5/10’s). There were also steps designed to ease pressure on the housing market, with early repayments from the Fed’s MBS portfolio set to be recycled into Freddie/Fannie paper, aiming to increase availability of mortgage refinancing. We suspect the effect will be rather muted, after all one of the principle obstacles that households have had when looking to refinance has been lack of equity or in many instances negative equity which is unlikely to change. The policy is instead likely to benefit those with sturdier balance sheets which are also probably the same people who would use such a windfall sensibly even if Bernanke really wants them to gear up and spend to kick the recession down the road a bit.
Looking at the potential implications our view is really unchanged from what we wrote on Monday, namely we think the curve had already priced in the bulk of the twist (at least 5-10’s) and that being short stocks and long the dollar has much more upside. Indeed, the immediate reaction in stocks was even more forceful than we expected and should extend from here. This really reflects the feeling that there is a widening void between Bernanke’s idea of what monetary policy can achieve and reality (The Chairman’s God complex is maybe one unkind way of describing it). Of course there are policy tools still available, underlined by Obama’s poorly received jobs package, but most have already been used and abused meaning the effectiveness of new measures (including the twist) will be muted. Weak data will reinforce the recession view which is still underestimated by the mainstream despite what has been going on.
Our expectation is we’ll see new lows in equities; a move through 1,100 would reaffirm our mid-term goal of 900 target for the S&P500, only a move back above 1,230/50 would suggest we’re wrong.
Equally the fortunes of the dollar index continue to improve, with the chart remaining extremely bullish. The break we identified on the 9th September (http://wp.me/p1G1Fr-cj) has performed as expected, retracing in the first instance back to the 200-DMA around 76.00 before accelerating again to make new multi-week highs at 78.30+ and confirming those 80+ targets in the process. The immediate objective remains a move through 80.682 and back towards the Dec/Jan top at 81.30/50. Ahead of there are some interim resistance levels, 78.70/90 area first and then the psychological 80.00 mark, but as we’ve previously noted they should be straightforward to clear if (as) risk aversion intensifies. Based on our 900 S&P view aiming for the dollar index to break up towards 82.59/83.55 would be fitting and even those 2008/2010 highs above 88.70 are not that fanciful. We’d tie that in with what we wrote here on brent too: http://wp.me/p1G1Fr-cr.
- Why Goldman Is Surprised By The Market’s Reaction To The Twist, And What’s Next For The Fed? (zerohedge.com)
- A few more analyst reactions to the FOMC statement (ftalphaville.ft.com)
View: Curve priced for ‘Twist’, EUR should weaken, Stocks have downside
Markets have a lot to digest this week, not only should we see some fruits/fallout of EU/IMF negotiations with Greece over its next bailout payment but Bernanke et al. are also convening for the extended September FOMC. Both could be pivotal, the first potentially delaying what we have long felt is an inevitable Greek default while on the other side of the pond there should be an answer to what type of stimulus the Fed is planning. Lots to get excited about then, though probably not enough to really end current uncertainty in any decisive way. Perhaps one way to describe this period is the eye of the storm; everyone gets a bit of a breather before it all kicks off again.
On the European side despite tough rhetoric from politicians none of the key issues really look to have been resolved. For example the German’s are still prescribing austerity to the debt stricken club Med and dismissing the viability of euro bonds, which would effectively place core Europe’s balance sheet on the hook for peripheral liabilities. At the same time Merkel continues to be vocal in stating Greece won’t be allowed to default. We accept that the euro has always been a political and not an economic project at its heart but find it difficult to believe that the EC, regional governments and central banks really buy into the idea that the current timeline of reform is adequate to prevent the crisis snowballing out of control. We’d side with the view that it already has, and that current press conference unity is merely part of this slow motion car crash in action.
This leaves plenty of opportunities in the market. Although the ECB’s expanded bond buying programme ended the game of playing the more exciting bond spread wideners volatility has migrated elsewhere with France still vulnerable not to mention the banks and regions equity markets. Finally the euro itself looks prepped to absorb more pressure. We maintain our view that selling the EUR is still a low beta way of participating in the crisis, the market quickly tagged our initially 1.35 target after the ECB meeting but still lower levels look reachable in the coming weeks (sub 1.30). The debt crisis is only one part of this equation. The dollar (DXY) also looks to have turned up, which is a natural EUR negative while rate differentials which had underpinned earlier strength are also now more of a headwind as traders look to price in an unwinding if earlier ECB tightening.
Moving on to the Fed meeting its difficult to see where the surprise is going to come from and following the market reaction to President Obama’s jobs plan even something aggressive may not please investors. The core scenario seems to be for the Central Bank to shy away from outright QE3 (many already of the view that QE2 was an abject failure) and instead delivering a derivative of the early 1960’s ‘operation twist’ whereby the bank would aim to extend the duration of its vast haul of UST’s, flattening the curve and according to Bernanke’s text book cheapen the cost of long-term credit. Unfortunately the market has priced this in already with the yield curve flattening by some margin over the summer (5yr-10yr spread tightened by approx. 35bps). This was of course helped by the Fed’s pledge to keep rates on hold through to mid-2013 but the real driver has been the dire economic data which seems to have encouraged most to just give up thinking about a first rate hike.
With the curve already looking like the Fed probably wants it too it’s difficult to think what would actually be achieved by stepping in to lower long-end rates. This also overlooks the fact that the transmission mechanism is broken anyway, underlined by the inability of house owners to re-mortgage due to falling equity levels and a general lack of demand for credit, highlighted both by companies cash piles and the vast amount of dollars lodged by banks (unwilling or unable to lend) at the Fed. And more importantly no one really believes operation twist worked in the first place, the economy was already turning up at the time and unlike now that recession was of the more traditional type (i.e not a credit bubble). With this in mind it looks prudent to book profits on any curve flatteners, or at least cut back on the short legs.
We’d also be inclined to be short equities based on the view that the Fed’s policy options are far narrower than Bernanke seems to think they are and thus so is the scope for a positive market reaction, or if not immediately disappointing enough for a sustained positive reaction. Technically there is still room for a push into the 1,230/50 area in the e-mini contract but the market should struggle to break out of the top of that band. We’d only reassess this view if we see a close above 1,259.
- John Mauldin On Operation Twist, And The Fed’s Latest Huge Bailout Of European Banks (articles.businessinsider.com)
- Twist and Shout? (ritholtz.com)
View: Any new Fed money printing should flatten the curve
August data was already looking rather bleak and this afternoon’s first estimate of last month’s non-farm payrolls merely adds to this view with a headline print of zero vs. the +68k median guestimate while July’s numbers saw a revision to +85k from +117k and June’s was dropped to +20k from +46k. The unemployment rate was unchanged at 9.1% but hours worked slipped again to 34.2 from 34.3. Even if you strip out the Verizon strike which explains around 45k of the headline drop it’s a pretty miserable report (-81k after lifting out strike and including revisions back to June). The knee jerk reaction from stock futures was to extend earlier falls unsurprisingly, tagging the 38.2% support line at 1,183 in the first instance. As we noted in our Wednesday update if the bears can crack this line and then 1,175 fear should pick up again.
However, the bleak payrolls number might be something of a double edged sword for the market. At first glance so negative but it will clearly increase pressure on Congress to respond positively to Obama’s new jobs programme due next week and of course Obama himself to reach for the more aggressive side of the proposals box. The doves on the FOMC should also find themselves with an easier task; it should have even more ‘bad data’ by then to lean on too. We already know Bernanke is fond of unorthodox measures and will no doubt have another crack at checking the equity decline in search of that wealth effect (hubris) which seems to be the only rabbit he wants to reach for in his rather shabby hat. The fact that stocks look behind the curve in anticipating the increasing chance of recession is lost on him. So it’s quite possible that knee jerk selling on the number turns into smarter buying from those building a book around a QE3 event.
We ought to be able to see some clues in how the deck is stacked by looking at the dollar index but this isn’t particularly inspiring on the chart at the moment, a little unusual given the impact Fed money printing has had on the greenback in anticipation of and throughout QE2. History never repeats itself exactly though; there should of course be further downside in the dollar (the capitulation phase if you like) but not to the same extent as 2010. Similarly there could be some initial demand for risk assets/stocks. We don’t think stock investors will be suckered so easily this time round, smart money should rotate to a more defensive posture – be it sector rotation or into bonds.
Where we think we should see a bigger impact is on the yield curve, short rates are pretty much anchored at zero and outright yields may look rich from a historical perspective but with inflation likely to subside due to the demand deficit and more supportive base effects (basic/industrial commodities may also suffer this time round) the longer-end should continue to outperform. This might even prove to be the exact route the Fed goes down, aiming to lower longer-dated yields either via rolling its existing holdings down the curve or possibly another round of outright purchases to expand its balance sheet with.
- Nouriel Roubini: 60% Probability of Recession (ritholtz.com)
View: Perhaps another 3% upside in the S&P, m/t still bearish
Much was made of the three more hawkish dissenters at the August FOMC but looking at the minutes it shows an even larger divergence in opinion between the voting members than this, some suggesting there was need for a “more substantial move” beyond the pledge to hold rates steady through to the middle of 2013. Given how the economy has developed since then their argument has only been bolstered (one hawk has already broken back towards the middle ground) and even though Bernanke’s Jackson hole speech last week didn’t offer up anything specific the addition of an extra day of discussion at September’s Fed meeting creates ample space for new policy initiatives which has not been lost on the market. We’ve also had dovish murmurings from other Fed Presidents, Evans (Chicago) most notably and Lockhart (Atlanta) although he is not a voting member this year. There is also room for Obama to offer up something new on September 7th when he is due to present his new job creation plan, requesting a joint session of Congress to help his case.
Even though bad macro numbers will continue to print and fiscal policy is due to tighten substantially next year the market’s focus appears to have shifted to these two upcoming events. It should even mean a poor payrolls number this Friday is more easily digestible. However, we’d see this as a short-term phase in what looks to be a more hostile point of the cycle with the market desperate for policy initiatives to stave of recession which the August data we’ve seen so far alludes to. Providing these come across as credible the response from traders should be positive – although after the bounce we’ve seen from recent lows we’d have to say a good chunk of this must now be priced. Even an outright QE3 type event wouldn’t leave us particularly encouraged longer-term based on the fact that QE2 didn’t have any lasting impact on macro fundamentals, Bernanke’s much loved wealth effect turning out to be largely fictional. The key is really structural reforms but things aren’t bad enough for that, and of course Congress is still heavily polarised after the earlier debt ceiling farce.
This leaves us looking back to our charts to try and work out where the market might top out. Around about here is really the immediate conclusion, though trying to supress our bearishness a little bit we’d pay close attention to the 1,248.5/1,258 area in the e-mini (ES1). A move back through this resistance band would mean bearish bets are off for the next few weeks at least. The bears meanwhile need to get the market back below 1,175/1,183 to create a fresh sense of fear. While the market remains in the middle of these two bands we’d prefer to take a more neutral stance, we’re still bearish but pragmatic and think there is more than enough room on the downside to play the market short on breaks if the opportunity doesn’t come to sell closer to the top of the range. For the day traders this might prove helpful, range trading perhaps becoming a viable game again as volatility settles back (for now) ahead of the next Fed meeting (20th/21st). While there is plenty of macro data to print ahead of then the market may well take a view that the worse things look the greater the ‘positive for risk assets’ policy response will be.
As a footnote we’d note it’s quite interesting to see how little yields have retraced despite firmer equity tone as well as the resilience of gold and the dollar. This triumvirate appears to be a better guide to the economic outlook at the moment that the traditionally lead indicator of the stock market, perhaps a little reminiscent of 2008. We’ll write more on this if we have some time.
View: Macro risks should mean gold pullback remains ‘corrective’
The slide in gold over the past couple of sessions continues with several bearish indicators appearing, such as engulfing patterns on the daily and weekly candle charts, Elliot Wavers meanwhile are identifying a wave 5 top and we’ve also seen divergences on some of our momentum indicators. There look to be some technical factors at work too with margin requirements hiked at a number of exchanges. Support at $1,723.60/$1,721.50 (pivot/trend from July low) was breached on stops this morning which adds further fuel to corrective pressures, switching the bears focus towards $1,700.00 and the $1,660 area.
But the underlying macro story is really unchanged, the global growth story is dimming at a time when central banks look to be mulling more stimulus measures (all eyes on Bernanke tomorrow), more money printing adding to pressure on the fiat currencies. This move looks like a shakeout of the weaker longs that bought into the recent rally alongside profit taking from more established longs following a near 30% gain over the past two months as well as hopes that the recent risk off move had gone too far, meriting some unwind in insurance trades like gold. Once these flows have been sated we’d expect to see accounts begin to accumulate again.
Some may already be tempted after a 10% pullback in the last three trading days, especially if the market can close above $1,723.60/$1,721.50, those medium-term accounts relying on the charts though should see the $1,643/1,660 area as the first point to get back in. We’d only begin to think this setback has more longevity if $1,580 fails, in turn brining the April range base at $1,470 into play. But we’re not convinced this is a viable scenario for the moment factoring in the macro backdrop leaving central banks under pressure. The market should also begin to fret over the implications of tighter fiscal policy in the US next year. Ultimately we think the gold ‘bubble has yet to peak. An appropriate comparison might be silver which remains in a longer-term uptrend despite the heavy correction we saw in early May.
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