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Fear Of The Bond Vigilantes Keeping US Equities On The Back Foot

Published 24/04/2018, 09:36 am
Updated 06/07/2021, 05:05 pm

Originally published by AxiTrader

Market Summary (7.43am Tuesday April 24)

The US dollar is on the cusp of a range break which could see the world’s second most crowded trade bust wide open in a round of short covering is the Greenback edges just a little higher.

In index terms, the US dollar is 0.7% higher with the US Dollar Index at 90.94 – tantalisingly close to the 91 break I’ve been looking at for ages now. Euro is down at 1.2205, off 0.66%, USD/JPY is 1% higher having busted its range top and is now sitting at 108.71.

Commodity bloc currencies haven’t fared much better with the Aussie down 0.9% at 76 cents – under the trendline from the 2016 low. A break of 0.7590 opens the way to 0.7475. The kiwi is down 0.8% at 0.7150 while the Canadian dollar lost 0.6% with USD/CAD up at 1.2835.

Why the sudden US dollar surge? To me it’s a simple recognition that the bond vigilantes might be right. As US 10's (2.97%) and 2's (2.48%) continue to rise with oil and inflation expectations policy divergence is a thing again. Especially given the US economy is likely robust enough to handle the uptick in inflation whereas perhaps Europe is not.

Oh and as BlackRock (NYSE:BLK) CIO for fixed income Rick Reider told CNBC last night – US nominal GDP could hit 5% this year. BOOM!

And even though 5% nominal growth should be a boon for stocks its fear of the bond vigilantes which is keeping US equities on the back foot. 3% is just a number, just a stop on the way higher me thinks. But change of big figures are always more important than they should be – and stocks are watching closely.

So at the close, the S&P 500 snuck back into positive territory for at 0.005% gain and close at 2,670. The downside – perhaps another 100 points – still beckons my charts suggest. The Dow is 0.1% lower at 24,448, and the Nasdaq 100 is off 0.28%.

Of note today on stocks, Alphabet (NASDAQ:GOOGL) has shot the lights out with its earnings after the bell (although as I write its stock is now negative), while Alcoa (NYSE:AA), among other aluminium firms across the globe, was hammered after it emerged the US might ease/end sanctions if the oligarch who is the major shareholder in Rusal sells down. That saw aluminium prices drop 10% on the LME from the morning high at $2,534 to $2,237 before closing down 7.5% at $2,295. And of course Alcoa (NYSE:AA) lost ground closing the day 13.5% down.

To Europe now and it was a better day with the DAX up 0.25% while the CAC and FTSE were up 0.42% and 0.48% respectively. That was despite some benign flash PMI’s for the EU (composite 55.2 unchanged) outside of Germany (comp 55.3 from 55.1 last) and France (comp 56.9 from 56.3 last) which suggest growth isn’t ending but the high water mark is past.

Here at home yesterday you would have sworn the Hayne Royal Commission had uncovered nothing rather than plenty, given the performance of the banks. Miners did okay to so we had an unexpected – at least by me – rally. Overnight SPI traders saw nothing to fear and have added another 11 points to yesterday afternoon’s close. We’ll see. CPI might be important today if it’s a big miss or beat.

To other commodities now and oil bounced back from the lows it plumbed after the Iranians suggested OPEC may not extend. It may be part of a sanctions mitigation strategy to signal to the newly interested US President that Iran isn’t trying to drive oil prices to $100 – that’s the Saudis. And it was because of missile attacks in Saudi that oil did manage to climb back. WTI and Brent ended the day up 0.75% and 1.26% respectively. Copper lost 0.83% and gold fell heavily under the US dollar's onslaught – it’s back at 0.24%.

On the day today the highlight for Australian markets is the Q1 CPI. Headline is expected to print 0.5% for the quarter and 2% yoy the Reuters poll says with the trimmed means printing the same quarterly rise but an inflation rate of just 1.8%.

Tonight we get the Ifo business climate, conditions, and expectations in Germany, Case Shiller house prices in the US along with new home sales and the Conference Board consumer confidence numbers. BoE Deputy Governor Wood is speaking as well.

No report tomorrow as we observe ANZAC Day.

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

International

  • Inflation expectations are rising folks. A lot of that, most of it, is because of the oil price. But it’s important because with a strong economy and inflation expectations rising long bonds have very little option but to sees prices fall and rates rise. As I’ve written above there is nothing special about 3% on a US 10 year – except of course the psychological impact and the fact everyone seems to have talked themselves into worrying about it. So, for the moment, as Pension Partners Charlie Bilello tweeted this morning, “5-year Breakeven Inflation Rate at its highest level since April 2013: 2.12%”. No wonder rates are rising.

Chart
Source: Twitter Screenshot

  • But here’s the thing, French President Emmanuel Macron is meeting with Donald Trump in the next couple of days and likely to press him on the Iranian nuclear sanctions deal. Over the weekend Macron said the deal is imperfect but still better than no deal. We also know that Macron and other US allies pressed the Administration on the Rusal sanctions and the impact that had had on aluminium, and other, prices. Last night the Administration gave some ground and aluminium prices fell. Now we come to the thing, oil is through the roof again this morning, momentum is on its side as traders await the early May decision on the sanctions deal. But with a very long market, a resurgent US dollar, and a newly interested president Trump in OPEC and the price of oil what if a deal can be done on Iran. Then we’d see a reversal in inflation expectations as oil traders unwind positioning. I’m getting ahead of myself here. But with oil having run this far the chance of this blow off leading to a rout are growing. Charlie’s making my life easy this morning – here’s another of his charts, this time on oil and its returns since the low.

Chart
Source: Twitter Screenshot

  • I know that all reads contrarian – on bonds, on oil, and on the Iran sanctions deal. It’s not meant too. It’s just that when everyone gets on one side of the boat the risks are skewed the other way. Just look at the US dollar these past few days. It just takes some time.

Australia

  • CPI data today is always critical to the debate on what the RBA might do. But given concerns about households, my sense is today’s outcome for Q1 price data in Australia will take on a materially greater significance given the current backdrop. It’s clear that the RBA does not want to cut rates. It’s clear the RBA has signaled – in its own and the governor's words – that the next move is likely higher for the cash rate. But it is also clear that with the unemployment and underemployment rates sticky and stuck at relatively elevated levels by global standards at the moment if the RBA wants to run the economy a little hotter to help households it could – as long as inflation remains quiet. We’ll know at 11.30am.
  • The outcome could be of vital import to the Aussie dollar down here on support at 76 cents. A weak read will increase chatter that rates are on hold for a very long time and increase the number of pundits – like me – who are willing to thing out loud that perhaps a cut wouldn’t hurt. The alternative is also the case. A bigger than expected rise in prices would put such chat to bed and likely see the Aussie find support. If so I’ll likely sell into that rally. Levels to watch, 0.7590 then 0.7530. Topside, it’s 0.7650, then 80.
  • 5,886. That’s the level to watch in the SPI today. If that break then we might be off to the races for a bit of a gallop toward 5,963. Why the heck the banks would be bid I don’t know – although the yield remains attractive. But if there is any news that’s interesting about the banks its that the CPR’s in securitised loans is falling. That implies less churn which in turn implies less opportunities for growth as APRA continues to clamp down on bank product. But investors are perhaps happy to sacrifice a growth rate for a dividend payment? Seems fair. Anyway, I’m off the reservation here, we don’t trade single stocks at Axi and I’m thinking about this in terms of how this dominant sector of our index can in turn influence the overall SPI movements. Likewise resources will be interesting today as well. We saw some big moves in China yesterday and then overnight in commodity markets. The washup may be negative.
  • So 5,886 may hold unless or until US stocks push higher.

Chart

Forex

  • Are we there yet? Not quite, but almost. The US dollar at 90.93 is a little above the 38.2% retracement level of the big recent fall that it has been consolidating for some time. And it is tantalisingly close to a break of the recent range – but it is not there yet as you can see in the chart below.

Chart
Source: Investing.com

  • Part of that is because the euro is also just inside the recent range sitting at 1.2207 this morning against a low around 1.2150. So we don’t have a break yet. Don’t get me wrong, As readers know I’ve been singing from the “let’s make policy divergence great again” hymn book for months now. And I am an unabashed US dollar bull. It’s just that as I’ve said often the best we can say about the US dollar is that it has stopped falling in this big overall and multi-year down trend.

Chart

  • But given positioning in the euro and negativity toward the US dollar – remember last week I highlighted US dollar short was viewed as the second most crowded trade in the BAML global money manager’s survey. The chance of this big break I’ve been waiting for are growing.
  • And if the euro does take out 1.2150 then I’m looking for 1.1950 and then 1.1712. Here’s the weekly chart.

Chart

Commodities

  • The Houthi’s chucking missiles at the Saudis, the Saudis killing a Houthi leader in a raid, its all part of the tapestry of geopolitical risk which has oil traders on edge as we get closer to President Trump’s decision on the Iranian nuclear deal. We know he doesn’t like that deal, he’s told us that. And we also know that Europe is in favour of it persisting. So we might get a compromise like we seem to be getting with the Rusal sanctions. Time will tell.
  • And just as President Trump can signal so too can the Iranians. They have said the US should stay in the deal and Reuters reports the Iranian oil minister said over night there is no need to extend the pact between OPEC and non-OPEC nations to extend the deal if oil prices strengthened. That’s a neat division inside OPEC from what the Saudis appear to want and a clear signal to the President the Iranians can play ball with his new interest in oil prices.
  • For the moment though momentum is with the bulls and buyers are stepping in when there are dips. Equally important is that prices are holding above the breakout level of $71.25 in Brent terms. Certainly this market is very long and extremely vulnerable at these levels. And my sense is a top may be forming. But I have no sell signal yet and the trend is still higher for the moment.

Chart

Have a great day's trading.

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