Diary: Week 7 of the rest of my life: Going dark

The title of this week’s piece could both refer to the Federal Reserve as it?enters its backout period, or me, as I prepare to head to Ireland tomorrow.

The Fed is no longer as diligent about maintaining its silence as it used to be (way to try and micromanage something that you have not very effectively macromanaged) courtesy of “vice chair Timiraos”.

I have not tended to be very diligent in staying away from markets IF things are interesting so cannot promise you will not see my version of Nicky T. However, I will be staying low key for the next 2 weeks and enjoying family, chillin' and rain, rain, rain.

So, I am not going to say- “What a week” in financial markets last week- because that has become every week.

However, some things worth noting are:

DXY down 2.3% in the biggest weekly fall since the week of 07 November 2022. This resulted in it finally breaking out of a consolidation in place since the week of 30th January. The basic rule of thumb is that the longer the consolidation, the more impulsive the break is likely to be, and we saw that last week.

This came after the bearish outside week posted the prior week. How much further can it go? At a minimum the 200-week MA at 98.25 looks a likely target although as we know that gave way on EURUSD on a weekly close last week.

On EURUSD would suggest a move towards 1.1483-1.1495 But we should be watchful about the possibility of “triple momentum divergence” on the weekly chart. (High, higher high and higher high on price combined with “overbought high” followed by lower high followed by lower high on momentum).

Also the “leader of this move” USDJPY hit and slightly exceeded our 107.71-107.97 target only to bounce sharply (barely avoiding a bullish outside day) ?while USDCAD has so far held the 200 week MA and posted a bullish outside day on Friday as yields rose and Oil fell.

Given the magnitude of the moves seen and some clear signs of more indecision last week, at the close, it might be worth some short-term caution in “jumping” on this USD selloff at this point.

While we saw the expected acceleration on the break of good levels on Oil (Brent and WTI) we have seen WTI once again hit a “brick wall” at the 200-day MA , suggesting that in the near term the move might be a little over-extended. Watch $75.06 here as?a break back below would at minimum temper the bullish setup

One of the biggest supporting dynamics for a weak USD is, as previously mentioned, is an environment of lower US yields and a steeper US curve. In particular we noted the positive technical developments on the US 2’s 10’s curve seen the prior week.

Last week, we saw that retrace somewhat and while yields ended the week lower so did the curve- which is not so unequivocally USD negative.

?In this respect it is worth looking at the underlying set ups in both the 2 and 10 year yield charts.

On the US 2-year yield we clearly have a double top formation after a failure to sustain to new highs. We also have a potential 55-200 week MA setup that is one of my top 3 indicators. This completes when.

• Price is above or below the 55-week MA for at least 2 years on a weekly close basis. The 2-year yield has been above the 55-week MA for 2 years and 2 months.
• At the peak price is very extended to the 55-week MA.
• An historically wide gap opens up between the 55 and 200-week MA’s
• We get a weekly close below the 55-week MA setting up for a move towards the 200-week MA

So let us look at what these patterns suggest (albeit that is clearly for another day.)

The double top neckline is at 3.55% and a weekly close below would argue for a move back towards 2%

The 200-week MA is at 1.69% and gently rising

These levels are extreme but let us just remember- The only thing unthinkable in these markets is that anything is unthinkable

Let us look at the 10-year yield chart which is rapidly looking like the most compelling directional chart out there.

Firstly, it hit a “brick wall” at 4.08-4.09% which was both the March 2023 high and the 76.4% pullback level. (Which is another of my top 3 technical indicators).

Subsequently it fell away sharply last week.

We once again have a 55-200 week MA setup here with the 200 week MA at 2.02%.

Following the 76.4% pullback the 3.25% low is now a big “acceleration pivot” and IF broken would suggest not just lower yields but in an accelerated fashion.?

So simplistically all of the above would suggest lower yields with bull steepening and therefore also a lower USD.

BUT, it is not as simple as that.

It would be, if we were in the low inflation environment of the last 30 years that sees the Fed react to the first indications of economic slowing and ease rates.

But we are not

What they do from here may be right or wrong (I am inclined towards the latter) but the one thing they will be is more stubborn than usual.

They will want to see the “whites of the eyes” in terms of victory before they shift from the “higher for longer stance.”

Even then, their first capitulation will be to move from “Skip” to “Pause”. The move to “cut” will be further down the path for them- but the market will likely signal that well before the Fed.

The big “Hawk” is on his way (Jim Bullard). You have to give him credit in that in this cycle he was the “least wrong” on the Fed board and very vocal regarding the need for speedy and significant rate increases. Chris Waller is now taking up that “Baton” with his recent statements that 2 more moves were needed quickly to “seal the deal”.

Really?

After 500 basis points of hikes from a Fed that “totally blew it” in 2021 we are now being told that “this last 50”, this final “fine tuning” is the “be all and end all” of the tightening cycle and imperative to success

Give me a break

The odds are clearly now that they will move in July. Despite the fact that we have seen notable inflation misses and also weaker employment data since the last meeting the data overall and markets have given them cover” to make the move.

The move suits their narrative so they will likely “take the easy layup” while likely not seeing Giannis Antetokounmpo powering behind them to produce a “highlight reel” block. i.e. Policy mistake.

There is no need for them to move now. They can afford to be patient but they will not likely be so.

This is about the fear of compounding the mistakes of 2021 but because of that fear they are blinkered to the reality of today and fighting yesterday’s battle.

Look at the World around us economy after economy heads to slowdown or recession (China, Europe, UK , New Zealand etc.). Headline inflation has collapsed and will continue to feed into the lagging core. Consumer savings are close to being tapped out. Anecdotal evidence clearly suggests that jobs are now being lost. Financing costs for banks, consumers, the Treasury and even the Fed have now moved into prohibitive/loss making territory.

The longer you wait to see your target (like 2021) rather than recognize the trend in that direction the more likely you will overstay your welcome and the Fed are “serial overstayers”

So how will this play out.

A number of weeks ago I looked at the various possible scenarios for the yield curve.

1. Bear flattening-a market that believes the Fed keeps pushing and will likely be true to its word of multiple renewed rate hikes.

2. Bull flattening - market is heading into full recession mode and once again thinking that "something is broken" and the?Fed is going to be stubborn

3. Bear steeping- the market is likely fearful of inflation deteriorating again

4. Bull steeping -the market is heading into full recession mode and once again thinking that "something is broken" and the?Fed?is?going to capitulate

I just do not see scenario 1 or scenario 3 as likely on a sustained basis.

However, for now, we are also not YET at scenario 4 with any real consistency. For that to happen the market has to fully believe that the Fed is done and that we are heading into a timeline that will start to shift them into an easing bias. While I think that will come, their “stubbornness” suggests that outside of a “tail risk” event that is going to take time

As a consequence, scenario 2 with the curve range trading or possibly even bull flattening a little is the short-term danger and then eventually morphing into a more sustained bull flattening.

As I said earlier that, in the near term, may not be as clearly USD bearish as the price action of the last week suggests while bull steepening would be much clearer in that respect.

It looks hard given this setup to bet too aggressively against the equity market.

Last week Es1 had its 2nd bullish outside week in the last 4 weeks and a move to 4,631 still looks in prospect and above there possibly even the highs of 4,808.

The only technical cautionary possibility is on the momentum indicator on the weekly chart which could form triple momentum divergence (negative). This has not yet happened and should not be pre-empted (just as in EURUSD) but it deserves close attention just in case it does occur in the weeks ahead.

?To sum up

The Fed should not hike this month, but it probably will because it can, and it fits the narrative. This move may go down in history as the “one step too far” that we regularly see from the Fed.

For now, this is baked in and should not send yields higher, but it will be hard for the 2- year yield to lead the move lower just yet.

While it is very possible/likely that the low is in for the 2’s 10’s curve it will not be easy to sustain further steepening in the short-term albeit that is still my structural view

Despite this, with a bias towards lower yields the Equity market could still sustain higher levels unless and until concerns grow. In that respect I would still keep on eye on the KBW bank and regional bank indices as I am not convinced that we are out of the woods there.

For now, I would be more cautious selling the USD in G10 given these curve dynamics and the magnitude of moves seen last week.

The break on Oil is still intact but momentum on that move has slowed after such a strong rally so caution should be warranted here short-term also.

?

That’s it for now

Stay well

Be safe

?

FITZ