Diary Week 10 of the rest of my life: Are We Having Fun?

After 2 weeks in Ireland (The only place in Europe that saw temperatures average about 64 degrees F with “soft rain” virtually every day during that time while everywhere else baked) last week I re-engaged with markets albeit on a more intermittent basis.

Who knows, 50 years down the line we might be talking about Irish West coast as the new European riviera. I’m not holding my breath.

So

Once again, I suspect that it has not been fun for people with strong 2-way choppy movements.

What thoughts stand out?

Well first and foremost we saw Another Dud Projection.

In my diary on July 8th I commented that

“The big market mover last week was the ADP release that claimed 497k jobs were created in the US economy in June

On the back of this release (06 July) the market went “apoplectic” with the 2-year US yield spiking to a new trend high of 5.12% above the March peak of 5.08%. On the day we saw an 18 basis point range followed by a 16 basis point range on Friday. We also saw a sharp fall in Equities and a bid tone to the USD.

Well, that projection was a?DUD,?as we saw when the NFP numbers were released on Friday.

That left the 2-year yield closing Friday at?4.9459%?having closed Wednesday at?4.9445%

Net net, literally nothing happened?(except I suspect a large P&L drawdown on a lot of portfolios)"

I finished these observations by saying that one thing we certainly learned was - Don’t ever look at ADP again. It has shown?ZERO?valuable predictive value for NFP.

Fast forward to 02 August and ADP prints 324K and what happens?

The 2-year yield again spiked to 4.12% (again) (The chart looks different now because we saw a new benchmark 2-year yield introduced on 15 July which reset the peak back to 4.08% again)

On the day we saw a 12-basis point range followed by a 17- basis point range on Friday

On 06 July the SPX closed down 39 points and on 02 August it closed down 58 points

On 06 July the DXY moved to a new high in its 2-week up move and ran out of steam. On 03 August the DXY peaked in its 2 ? week up move and ran out of steam.

History may not have repeated but to quote Mark Twain it sure as hell “rhymed”

But we finished the week quite differently to that week in July in a number of instances.

Yields

The 2,5 and 10-year yields not only fell on Friday but all posted outside days with the 10-year yield posting its outside day off the trend high of the whole move up from May.

Up until yesterday at no point did the 2-year yield in that whole move higher from May at 3.65% post an outside day to the downside. Neither did the 5 or 10-year yield (until yesterday) .

While only a daily development it is one not seen on any of these charts for 3 months let alone on all three charts at once.

In addition, I noted that 4.08-4.09% on the 10-year yield was a very pivotal level and could not be ignored IF we saw a weekly close above. On Thursday and even on Friday morning that looked a “done deal” as it hit a high of 4.20%. Then post payrolls it reversed sharply only to close at 4.04% and yet again (like July) likely leave a lot of “dead bodies” on the street (figuratively)

Make no mistake, that was a big failure.

That level was strong resistance from both the February and July highs as well as the 76.4% pullback of the Oct 2022-April 2023 fall.

In addition, we finished the week with an inverted hammer (Similar to the multi week peaks seen in both June 2022 and Feb 2023.)

This would suggest (at least for now) that we could be set for a multi week fall in yields with first strong support at 3.72% (Retracement low in July)

This is WAY TOO EARLY, but I am going to go there anyway as a ”heads up”.

I am closely watching the monthly chart on the 2-year yield. WHY?

Firstly the peak at 5.12% is virtually the same level off which the turn lower began in June 2007 with an indecisive month (Doji) just like we saw last month.

After that indecisive month in June 2007 we saw a sharp fall in this yield in July to a low of 4.48% completing a clear evening star formation and settiing up for significant sustained losses in the months ahead.

A sharp fall in the 2-year yield, this month, IF seen would complete a similar pattern further suggesting that a top is in.

Much more importantly, a further fall in the 2-year yield this month could create one of my top 3 (if not the top 1) indicators- Triple momentum divergence.

What is that?

Triple momentum divergence (most notable if seen at a trend high or trend low) happens when (In this instance I am looking at a trend high and the reverse would be at a trend low) you set a high in price (4.8% in November 2022) followed by a higher high (5.08% in March 2023) followed by a higher high (5.12% in July 2023)

At the same time as this happens momentum (slow stochastic) sets a high in substantially “overbought or extended territory” followed by a lower high and followed by another lower high. These highs are deemed completed when we see the %D cross over and close below the %K.

Right now we have clearly got (intra month) the high, lower high and lower high this month so far. If the 2-year yield falls further, we have a very strong possibility that we will see that crossover take place.

I cannot emphasise enough how big a technical development that would be in my view.

It would both suggest that the trend high of this 2-year move is in and that we could retrace quite sharply with an obvious medium-term target being the June 2023 trend low at 3.55%.

In addition, IF such a move was to take place that would leave the 2-year yield (subject to no further moves from the Fed) nearly 200 basis points below the upper band of the Fed funds rate.

The last time we got close to that level was in Jan 2008 (low of minus 190 bp’s) and before that in Jan 2001 at minus 164 bp’s. Then you need to go back to July 1989 at minus 167 bp’s and November 1981 at minus 188 bp’s to see anything like those numbers.

Outside that only the Volcker “hyperinflation” years saw greater inversion as real and nominal yields were taken to stratostrophic levels.

I am not saying at this point that this is a 2008 or a 2001 or a 1989. We may not even complete this technical picture.

However, what I am saying is that if we do see this develop we need to be very cognizant of the suggested implications.

Right now, I do not see a housing crisis as borrowers are still protected on cheap refinancing, unemployment remains very low and supply is still an issue.

Inflation has been falling for over a year, so I do not see that at this point as a renewed catalyst.

Banking issues cannot be ruled out as the stress of higher funding costs remains in place in a manner similar to the savings and loan crisis.

There is little obvious sustained credit or mortgage stress like in the GFC

So, in some ways the equity market and the dynamics of 2000-2001 seems the candidate most in focus although that still seems too early as I still see people getting very excited on every dip.

That is not normally how a top is put in. Normally (like in late 1999) that happens when all the sceptics get dragged in. In 1999 we finished the year with the NASDAQ composite up 85% and the S&P up 20%

?Equities

Right now, there are no strong big picture warning signs but there are however a few notes of caution.

Es1 almost perfectly met the 4,631 target on 27 July (peak of 4,634) after which it posted a bearish outside day at the trend high. It posted another bearish outside day on Friday and is “hugging” good support at 4,498. If that gives way, then extended losses towards 4,406-4,409 could be a danger.

Only below there would the level of concern grow.

Of some concern also is that we have completed triple momentum divergence on the weekly chart increasing the danger that we could see that move towards 4,406-4,409

In addition the NASDAQ Composite (chart not shown) did complete a bearish outside week last week as did the DJIA

There is no doubt that the late day performance in the Equity markets on Friday was “less than optimal” especially given the sharp fall in yields.

It is worth noting, however, that in the July week (ADP/NFP) referred to above the ES1, SPX, NASDAQ Composite and DJIA all had down days that Friday despite the sharp fall in yields only to recover strongly the following week.

HOWEVER, they did not have any of the technical developments mentioned above so increased caution is warranted this time.

FX

The USD-Index has been rallying strongly over the last 3 weeks following the very clear positive triple momentum divergence on the weekly chart (Negative divergence on EURUSD)

On the daily chart the DXY

• Failed to sustain a break above the 76.4% pullback level as well as downward sloping trend line resistance.
• Posted an evening star formation at the top of the up move (bearish)
• Saw momentum turn lower from overbought levels.

All this would suggest that a retracement back towards good support around 100.55 could now be a danger.

As mentioned earlier that last rally in the USD-Index peaked on Friday July 6th after the employment numbers and the USD fell sharply the following week.

In that respect USDJPY could be very vulnerable as it struggled to rally when we saw yields pop sharply on Wednesday and Thursday. In fact it fell on Thursday and again on Friday. If it cannot rally on yields popping like that it would look very susceptible if yields continue to fall- possibly even towards or below 140 again

In addition, If yields continued to fall and the 2-year yield leads the way (Bull steepening) that is not a favourable setup for the USD.

?What does all this suggest?

The US 2-year yield made a trend high in March and has struggled to make incremental gains since. While it did set a new short-lived marginal high (Unlike in June 2007 at the same level when it was a marginally lower high) the potential technical set up could be warning of a structural high around here.

For that to happen we likely need a Fed pause rather than skip (now looking highly likely) and data that eventually suggests renewed easing. Inflation has been falling since June last year and CPI data next week is likely important here.

The employment picture is clearly moderating albeit not yet deteriorating. Initial claims remain subdued and the employment rate is just 1/10th off the trend low.

However, ECI has continued to fall in the first 6 months of the year, JOLTS are now nearly 2.5 million off their March 2022 peak, Quits are falling, NFP has now been revised lower in every one of the prior 6 months this year (cumulatively lower by 236k) and the July ?print last week at 187k is the lowest number since Dec 2020. It has also missed expectations in the last 2 prints (Despite the ADP head fakes)

At minimum there is a reasonable argument to say that the labor market strength is moderating

The Fed’s mandate is to keep employment and inflation low. Employment is low and softening and with headline inflation (CPI) at 3% real yields are notably positive.

As noted by Bostick last week there is nothing at this point to suggest they should continue hiking.

We are therefore likely moving into the steady for longer rather than higher for longer phase of this cycle.

I have constantly argued that even steady for longer has a negative funding loop (Banks, Treasury, Fed balance sheet and eventually down the line for Corporate loans and mortgages although that is likely a 2024-2025 issue) due to the incredibly low funding and investment rates seen in 2020-2021 and that clearly remains a work in progress.

For now though, we should be thinking more pause than skip and that should have implications for the 2-year yield (Peak) the curve (steeper) and as a consequence possibly a lower USD.

The equity market is a work in progress. Ther are clearly some short-term concerns but it is not obvious that the peak is in yet.

A final chart that needs to be watched as it could be important in “rounding this circle” is Oil. In particular I am looking at the chart of Brent which has behaved very well technically. It reached the $85-86 target, but the more important question is what is next?

It completed a very clear double bottom on the break of $78.66 and reached its objective. that double bottom was formed off the 200-week moving average. There is now the possibility of an even bigger double bottom on a break above $87.49 (weekly close at least)

If seen that would suggest levels well north of $100.

If that were to happen it could be a very important part of how the picture above plays out and increase again the fears of a second round of Oil effects on inflation like we saw in the 1970’s.

However, it is also worth noting that the setup looks very similar to January 2020 when Brent not only did not complete the double bottom break but posted a bearish outside week just shy of that neckline which then became a bearish outside month leading to a sharp multi month drop thereafter.

All this suggests that this $87.49 is HUGELY important to watch

That’s it for now

Stay well

Be safe

?FITZ