A Nervous Start To The Week For Traders

Originally published by AxiTrader

Market Summary

US non-farm payrolls and the associated wages data was strong enough (200,000 and 0.3%) to worry traders that that the Fed may need to increase rates more than the 3 they have said and that many pundits are even now only reluctantly admitting is likely.

So, it’s going to be a nervous start to the week for traders across all markets as they wonder if last week’s reversal in US stocks and the ugly close Friday - which left the S&P down more than 3%, US 10-year bonds at 2.85%, and a US dollar recovery underway - is likely the start of something bigger.

Risk assets like the Aussie and kiwi dollar’s came under heavy selling pressure in the wake of the combination of events but a helicopter macro perspective suggests markets haven’t really kicked off yet – not in the way they might. I say that because gold, the yen, and the Swiss franc haven’t caught a bid. Yet.

As I highlight below technical there is good reason for the S&P 500 to pull up where it has. But Friday’s 2.12% drop and close at 2,672 was a return to volatility note seen by many traders for some time. It will have spooked the leveraged retail traders who are such a part of this recent melt higher. The question, as we open the week, is whether or not more selling eventuates this week. It seems a high chance.

Anyway, besides the 2%+ fall in the S&P the Dow lost 2.54%, the Nasdaq dropped 2.05% while the FTSE, DAX and CAC have got some catch up to do when they open this afternoon having only lost 0.63%, 1.68%, and 1.64% respectively.

SPI traders too with just a 65 point, 1.07%, fall may be a little underdone. Especially since the ASX 200 closed the weeks at the lofty height of 6121, just 30 points below the recent high. We’ll see.

On forex markets the Australian and New Zealand dollars came in for heavy selling as the US dollar gained its footy and as the sellers hammered the Aussie lower now that the buyers appeared exhausted. At 0.7917 this morning the AUD/USD is around 2 cents below last week’s high – lower levels beckon.

Elsewhere the euro is still strong at 1.2436 but a question mark has been raised over its outlook as the US dollar makes traction elsewhere. USD/JPY is back above 110, the pound is back at 1.41, and against the Swissie USD/CHF is back above 93.

On commodity markets oil was lower with WTI ending the week at $65.45 while Brent closed at $68.58. Gold is back at $1332, while copper fell out of bed a little and is back at $3.18, down 3 cents a pound.

On the docket today is the raft of global services PMI including the Australian, Chinese, Japanese and then of course US versions tonight. On the week it’s fairly quiet globally but we do have meetings from the RBA (plus its SoMP), the Bank of England, and RBNZ.

Here's What I Picked Up (with a little more detail and a few charts)

International

• Data and Fed: US non-farms were up a solid 200,000 in December data released Friday showed. That coupled with another solid 0.3% increase in average hourly earnings which took the yoy rate to 2.9% - from 2.6% - and the 4.1% unemployment rate contributed to the growing sense that the US economy really is doing well right now and that the added stimulus from the tax cuts – and the trickle down we are seeing from that – will see it continue to print solid growth numbers.

• And of course that reinforces the notion not only that the Fed will hike the 3 times they say they will but perhaps an additional one, which I’ve had pencilled in as readers know. On that front both Robert Kaplan of the Dallas Fed and John Williams from San Francisco were upbeat on the outlook for growth with Kaplan in particular saying he sees rising inflation pressures. Indeed Kaplan said he is more confident in three rates hikes but I thought Williams comment on bonds was telling. With reference to bonds Williams said the bond market’s move was a “delayed reaction” to growth noting, “Some of this adjustment seems to be a realization the economy’s doing really well, and obviously with the tax cuts that’s going to add further stimulus in the next years, and if anything the inflation data are heading in the right way”. Tellingly in a comment which gives me a sense of the bond market in 1994 he said, “Markets sometimes take a while to get going and then they move more quickly”. That of course is an axiom that’s as true in any endeavour of life as it is in markets. Once things reach a tipping point they more often than not accelerate very quickly. And Williams, and of course me, thinks bonds have tipped.

• And, even though she’s not Fed chair anymore or perhaps because of it Janet Yellen had something to say about rates Friday too. She said the economy is growing “at a healthy, solid pace” that “the job market is strong and inflation is low”. Consequently she said (my bolding), “the job market is strong and inflation is low ... The Federal Reserve has been on a path of gradual rate increases, and if conditions continue as they have been, that process is likely to continue, and as it does we would expect long rates to move up”.

• Dennis Gartman says one of the pre-requisites to know when a bull market has turned – or the bull is running out of puff is that prices fail at trendlines that can be drawn with rather wide pencils. So with stocks swooning after last week’s more than 3% loss on the S&P 500 it is worth again sharing the chart of the S&P 500 stretching back to low in early March 2009 at 666. With a tren that long you do need a fat pencil because even the smallest adjustment to the rate of climb means the resistance can be 50 or 100 points, perhaps more after almost 9 years, higher of lower. But in principle, I think it is fair to say the S&P 500 has pulled up where it should have. At this most influential trend channel in markets post GFC. Combine that with bonds breaking up and through their 30 year downtrend and we have a potent cocktail for market disruption and dislocation.

Australia

• It may not seem fair, but it’s a reality that even though the S&P/ASX 200 underperformed the global rally in 2018 it will suffer under the downward draft of stocks globally for however long that lasts. Of course it could be just a day or two more as the buy the dip crowd enters the fray. Or, after such a long period without a decent and material retracement, the smart money waits for a deeper move to re-enter the market. It’s hard to tell but the charts suggest a decent pullback globally and that means the local market can come under pressure.

• Of course a large part of that potential weight on the ASX is the cycle of reinforcement between the US dollar recovery that is coming at the same time stocks fall which in turn puts pressure on commodity prices and thus local stocks. Iron ore and copper actually have a reasonably low correlation with the euro and US Dollar Index right now at 0.4 (absolute value in price movement terms) for copper and 0.09 for Dalian iron ore over 35 days. Even the ASX 200:S&P 500 price correlation over 35 days is below 0.4. So the local market should be inoculated to a certain extent. Yet it is hard to imagine it will be.

• The key, again this week, is going to be 5,990 in the physical ASX200 and 5,935 for the SPI. The market bounced neatly from those levels last week and Friday ASX 200 close at 6,121 is a significant way above support. So too is the SPI’s close at 6,006 Friday night even after it lost 1% and fell 65 points. But these moves can become self-reinforcing, especially in Asia on a Monday. So if the region kicks off badly with a significant downdraft we could see the ASX lose more than the 1% futures traders are betting on. 5,987, Thursday’s low for the SPI looks to be to be the level below which a void could open up if prices break it.

• The Aussie dollar fell completely out of bed Friday and at 0.7917 this morning is down 150 points from the Thursday session high. It’s down around 200 points, 2 cents, from the high of last week in what is clearly a significant reversal. As I wrote last week the Aussie was hit by a combination of concerns over the RBA outlook after the lack of inflation evidenced by Q4 CPI last week and the growing cabal of traders, investors, and banks who said the Aussie was overvalued at or above 80 cents. The sentiment shift was distinct enough that we saw the very buyers strike necessary for the rally to end. And then the sellers came for the Aussie.

• The question is where to next. The reality though is this is still in no small part about the US dollar. So it’s recovery is going to be key. As I’ve highlighted above the iron ore and copper correlation with euro and US Dollar Index is very low so there is no direct feedback loop there right now. But even though the AUD/EUR 35-day correlation dropped from a peak around 0.98 recently to 0.90 at week’s end the euro and US dollar moves are still going to be important. To that end it is worth noting the US dollar looks to have found its feet. And with sentiment turned against the Aussie the 0.7893 Fibo support of the rally from 75 cents looks to be surely tested with the 50% at 0.7819 and the coincidence of the 200-day moving average and 61.8% retracement of the upmove at 0.7745 now my trading target. It’s unlikely to be as linear a move as we saw Friday though. Even though the Australian dollar is notorious for climbing the stairs and then falling down the elevator shaft.

• And just before I go, have a look at the AFR’s interview with Treasurer Morrison in this mornings edition. It’s interesting for a few things that stood out to me. First, he’s running the Howard/Costello playbook in terms of being conservative with his numbers. In the current circumstance that means he’s building a war chest for tax cuts on both a corporate and personal level. The second is the housing slowdown is worrying him. He lauded APRA but said the macro pro rules are “malleable”. You can have a look at the full article here while the specific one on the potential political pressure coming on APRA and the RBA to back off on Macropru is here.

Forex

• If you recall that I wrote recently a necessary precondition for the turn in the US dollar was a breakdown in the strong and very high correlations across currency and other markets with moves in the euro and the US Dollar Index. It is just starting to show up in the daily price correlations as highlighted in the AUD/EUR correlation. But at shorter time frames it was evidence a little earlier last week once the yen bottomed. So there is every chance – particularly with traders needing to do a recalibration about the whole policy convergence/divergence debate which has so helped the euro since mid last year.

• It is my strong contention that the ECB will end QE this year, even blind Freddy can see there is no need for emergency measures any more. BUT, they will be in no rush to tighten while their inflation performance continues to undershoot. Of course, high oil prices and any success/leakage from IG Metall's 6% wage campaign can change that paradigm. But behaviourally the reason I think we hear so much from the hawks in vocal public disquiet about QE is because they are losing the battle at the board table. That’s something the Algo’s don’t get.

• Looking at the price action the USD/JPY hasn’t just bounced off the bottom fo the range it has also broken a recent downtrend. But the yen’s action is likely complicated by this stock market selloff. The BoJ signaled strongly it doesn’t want JGB’s to join the global selloff by conducting operations to anchor the 10-year in its target band. That, in turn, help the USD/JPY lift. But at times of market stress the Yen usually does well which could otherwise complicate the bullish outlook for USD/JPY.

• The euro, of course, is yet to break. But it has stopped making new highs which is the first sign of stalled momentum. My rhetorical self, believes euro needs a pullback. And further that the fed ECB divergence trade could make this a decent one. My trading self, my system too, is more circumspect. A break below Thursday low at 1.2384 would be the first sign of a turn. But a move below my fast moving average at 1.2340 and last week’s low at 1.2334 would really change the game. Here’s the chart.

Commodities

• Oil markets have different drivers than stocks and currency markets. Naturally that is the case. And it is fair to say that the daily price correlation between oil and the Euro/DXY is breaking down. Butu it is still quite high with the Australian dollar. That suggests there is both an element of US dollar AND risk appetite, as well as global growth, which has fed into the strong price action of both WTI and Brent recently. Indeed last week’s resilience of oil prices to the announcement of the big increase in inventories and that US production hit 10,000,000 barrels a day in November was a reflection of a weaker US dollar as much as the buy the rumour sell the fact trade.

• So, with price action looking toppy in both WTI and Brent, I am on the look out for a reversal. In one of my video last week I highlighted that I wouldn’t rule out $61.50 for Brent at some point. It’s the 38.2% retracement level of the big rally since mid 2017 and as such just a garden variety pullback. Before that though there is a bit of wood to chop and last week’s lows would need to give way. Here’s the Brent chart – WTI looks similar.

Have a great day's trading.