Market Prep for the Week: April 15th

Last week, stocks pulled back due to a hotter-than-expected CPI print, which was highlighted as a potential risk in last week's post. Geopolitical headlines also created near-term uncertainty. On the same day as the hot CPI data, we witnessed the weakest 10-year Treasury auction in over two years, with dealers taking down approximately 24% of the total allotment—an approximately 70% increase in dealer action from the previous month. Now, this weak auction was not surprising after reflation fears began to be priced into the market. The yield curve is still inverted, meaning shorter-duration Treasuries have a higher yield than longer-duration Treasuries. These inversions are unique to the monetary cycle, but it is important to remind traders that traditionally longer-term assets deserve a higher yield due to opportunity cost and implied risk. If the reemergence of inflation is persistent, longer-duration assets may begin to re-rate higher. This is also known as a bear steepener, which is considered bearish for equities. However, we normalize the yield curve either through Fed cuts (which will need to be more than 75 bps this year to normalize the curve) or through natural attrition, setting up the economy for a long-term foundational base. The PPI data provided some short-term bright spots as they mostly came in line with market expectations. Notably, gasoline pressures increased last month, but diesel prices remained flat in most places within the United States, a key component for PPI. The inflationary pressures reflected in PPI also showed increased fees from brokerage and insurance products, which are variable and tend not to be persistent. However, one data point should not change the landscape right now. PPI is very volatile and traditionally requires sustainable uptrends or downtrends for three months or so to indicate signs of trends changing in CPI or PCE.

Over the last two weeks, we saw a near-perfect case study where the U.S. Dollar gained strength alongside energy commodities and metals across the board without any strong catalyst, except for Iran attacking Israel over the weekend. The risk-off trade/reflation trade was fully displayed within the commodity complex, keeping this type of correlation relationship in mind as it may be a sign of preparation for future geopolitical events.

From a technical standpoint, we observed some damage in the S&P 500 but cannot conclude that this is the start of a significant pullback. At a minimum, a potential bull-flag has been established when observing a daily chart. A bull-flag occurs when a bull market experiences a pullback in a channel-like formation, making lower highs and lower lows on a relative basis within the channel. The market traditionally checks back to an area of support, consolidates, then breaks higher out of the channel. I’m not saying this will be the exact scenario that will play out, but it does warrant a mention since almost every skilled technical analyst is looking at the same setup, so you should be aware of it too. Two concerning areas for me from a technical standpoint that I want to highlight are:

1. The 20-day SMA has acted as a clear area of resistance over the last four trading sessions. Before the pullback, the
2. Over the last two weeks, liquidity dried up, creating dynamic intraday market swings. When liquidity is low within the market, it usually does not take much to move markets either up or down and is usually a sign of a consolidation period for the broader market. I usually measure liquidity using the CME’s Liquidity Tool and analyze the trends of the average lot size on the bid and ask. I’ll break that down another time but know that it is an important gauge that can be the deciding factor for technicians.

For this week, the economic data is light on the inflationary front, giving bulls a little breathing room. The biggest headline data point will be Retail Sales, a key gauge that measures consumer spending on a non-inflation-adjusted basis. This number appears to be a bullish event on both fronts. If the data set comes in better than expected, meaning higher than market expectations, traders could view it as a sign of continued strong consumer spending. This could also be seen as an inflationary sign. However, right now the market should hope for stronger job numbers and consumer spending data considering inflationary pressures. If we see a weak print, the market may also view this as a bullish development for pushing up rate-cut expectations and potentially a sign that consumption demand is gradually decreasing, which may relieve some inflationary concerns. Several regional Fed surveys will also be published this week from the New York Fed and Philadelphia Fed. The key component to focus on for both of these surveys will be the Prices Paid component. Input costs for raw materials have seen some elevated price movements over the last several months, so that may start to be reflected in the survey. Also, keep an eye on any commentary that comes out around the Port of Baltimore’s impact on shipping. Granted, this event occurred on March 26th and may not be captured within the survey, but we may see some high-level commentary around initial impacts.

KG’s Focus for the Week (U.S Dollar, RTX, Brent/Crude Spread)

First and foremost, the rapid events over the last 72 hours are unfortunate on all fronts, but this is something that has been developing over the last several decades, so discard your conspiracies as they may cloud your judgment on positioning. From a pure markets’ standpoint, the biggest concern should always center around supply lines and logistics. Nothing more, nothing less. From a high-level perspective, nothing on the logistics front appears to be impacted for the time being. Iran has signaled that its strikes, for lack of a better word, were “retaliatory” in nature after Israel struck a consulate in Syria to target high-ranking Islamic Revolutionary Guard Corps (IRGC) members. According to the IDF, Iran launched over 170 drones, 30 cruise missiles, and over 120 ballistic missiles over the weekend. The majority of these munitions were intercepted by Israel and its allies, and for most of the West, they believe, given the circumstances, that was a “win” in many respects. The question is if and/or when Israel responds. Until then, energy commodities and currencies may be in a holding pattern. Do not base a trading decision solely on geopolitical events; there is a lot more going on behind the scenes than we will ever know, and the dynamics of a conflict can change on a dime.

Dollar Index

The strength of the U.S. Dollar

$DXY

is unsurprising given the reflation data points, geopolitical concerns, and the flight to quality trade that occurred at the end of the week. This week, the dollar may see some stagnant price action or even an unwind in price incrementally to start the week. Continued U.S. Dollar strength diverging from the key 104-104.5 level consistently puts pressure on equities, and any continued advance higher may result in the same equity price action. The Japanese Yen should be the focus for the U.S. Dollar Index as it has advanced above the key 152 level that many market analysts have viewed as a vague redline that may force the Bank of Japan to enact more aggressive measures to stop the rapid devaluation of the Yen. If you think the U.S. Federal Reserve is in a rock and a hard place, the Bank of Japan has two choices: continue to devalue their currency or sacrifice their JGBs (Japanese Government Bonds). Lower Yen sparks export demand, which is a tailwind for their economy on an export basis, but albeit the Yen is only around 14% of the U.S. Dollar Index, their underlying funding structure may have an impact on U.S. Treasury demand.

Defense Sector

It’s quite obvious the market will focus on defense stocks this week, given the events over the weekend. However, not all defense stocks are the same. RTX, formerly known as Raytheon, may see some positive order flow over the coming weeks and months due to this conflict specifically. RTX developed the Iron Dome System along with Israeli defense company Rafael Advanced Defense Systems Ltd. The Iron Dome is the defense mechanism that defends Israeli skies from incoming rockets and drone targets launched from ranges of 4-70 km, according to RTX. The key is not the battery system itself, but the Tamir missile, which is used to strike incoming targets and is also manufactured by RTX. Some estimates over the weekend state that Israel spent the equivalent of $1 billion on munitions (across multiple platforms) to hit incoming targets, as the system launches several Tamir missiles to hit one target. It is very expensive and can expend a fair amount of munitions in a short period of time, as we saw over the weekend. The backfilling of those munitions will be a top priority as Israel and its allies may be focusing on passing fiscal measures to expedite the production of these missiles.

Brent/Crude Spread

The minute an escalation event occurs around the Middle East, the market immediately focuses on the price of oil. As I’ve stated in the past, the fundamental case for oil between $80-$85 with current production levels and demand has seemed to find an equilibrium at that price level for the time being. If you believe the demand for oil will spike because of the events over the weekend, then focus on the spread between Brent oil and WTI crude oil. Brent oil is the global benchmark for oil and represents, very loosely nowadays, the relative price of oil around the North Sea. WTI crude oil is the price traditionally referenced here in the United States and is used as the benchmark for light sweet crude produced here. Once again, this is a very oversimplified explanation of these two products, but the topline thesis remains the same. If the spread between Brent crude and WTI crude contracts, that would be your signal for spot market demand, especially for U.S.-produced petroleum products. That spread traditionally measures the transportation and storage costs for moving American-produced oil to international markets. Once again, a simplified backdrop. Unless the spread narrows, a sustainable price advance due to the event does not seem to be in the cards, all else being equal. Once again, go back to my previous statement around geopolitical events and markets, the “biggest concern should always center around supply lines and logistics.” Right now, logistics have not been impacted yet, and supply lines have not been impacted. From a logistical standpoint, the Strait of Hormuz is your critical logistical route that could put upward pressure on oil prices if Iran wanted to aggressively restrict access or even target maritime shippers similar to what is going on in the Red Sea.

From a supply standpoint, it is not in the best interest of America to have Iranian oil extraction sites targeted, and I would not put it past the administration that this is one of the items they’re cautioning Israel on. Will we see an increase in sanctions? Yes, but energy traders know the low impact these sanctions have on energy flows for international markets. Think of it as an “out of sight, out of mind” situation. News outlets are also speculating that the SPR could be tapped again to put downward pressure on gasoline prices and maybe leverage this event as an excuse to do so. Right now, there is no need to tap the SPR, and that would be a policy error on the energy front.

Treasury Auction Reference Guide for the Week

Economic Calendar

Fund Flows

Economic Data Reference for the Week (AI-Assisted)

Retail Sales Ex Gas/Autos MoM:This measures the change in the total value of sales at the retail level, excluding automobiles and gas stations, which can be volatile. An increase is often seen as bullish for stocks, indicating consumer spending and economic health, while a decrease may be bearish, suggesting a slowdown.

NY Empire State Manufacturing Index: This index gauges business conditions for New York manufacturers and a higher reading is typically bullish, suggesting industry expansion, while a lower reading can be bearish, indicating contraction.

Retail Sales MoM:It measures the monthly change in the total sales of retail stores, reflecting consumer spending patterns. Higher retail sales can be bullish for stocks, signaling a robust economy, whereas lower sales can be bearish, indicating potential economic troubles.

Retail Inventories Ex Autos MoM: This metric shows the change in the value of unsold goods held by retailers, excluding autos. Rising inventories can be bearish, suggesting potential overstocking, while declining inventories can be bullish, implying strong sales.

Business Inventories MoM:This indicates the monthly percentage change in the amount of goods held by businesses, with increases potentially being bearish (overstocking risk) and decreases possibly bullish (indicating stronger sales).

NAHB Housing Market Index: This index reflects the level of demand for new home construction and the general health of the housing sector. A higher index is bullish for housing-related stocks but may also indicate broader economic optimism, while a lower index could be bearish.

NOPA Crush Report:It reports on the soybean crushing activity, which can affect soybean prices and related sectors. A higher crush number is bullish for soybean processors and bearish for prices, while a lower number suggests the opposite.

API Crude Oil Stock Change: Measures the change in the number of barrels of crude oil held in inventory by commercial firms; a decrease can be bullish for oil prices and bearish for stocks if it suggests tighter supply, while an increase might be bearish for oil prices and potentially bullish for stocks due to lower energy costs.

Housing Starts MoM:Tracks the number of new residential construction projects begun during the month. An increase can be bullish for the economy and stocks related to construction and housing, while a decrease can be bearish.

Building Permits MoM:This measures the change in the number of new building permits issued, predicting future construction activity. More permits suggest bullish sentiments for construction and housing stocks, while fewer permits can be bearish.

Redbook YoY:Compares weekly sales at major retail chains to the same week of the previous year. Higher sales growth can be bullish for retail stocks and the economy, while slower growth can be bearish.

Manufacturing Production MoM:Reflects the total output of the manufacturing sector. An increase is typically bullish for the manufacturing industry and overall economy, while a decrease can be bearish.

Capacity Utilization:Indicates the percentage of available resources being used by manufacturers, mines, and utilities. Higher utilization can be bullish, suggesting strong demand and potential inflationary pressures, while lower utilization can be bearish, indicating slack in the economy.

Industrial Production MoM:Tracks the output of the industrial sector, including manufacturing, mining, and utilities. An increase is bullish as it reflects economic growth, while a decrease is bearish, suggesting a slowdown.

Fed Beige Book:Summarizes economic conditions reported by Federal Reserve Districts. Positive reports can be bullish for stocks, indicating growth, while negative assessments may be bearish.

Net Long-Term TIC Flows:Measures the flow of financial instruments into and out of the United States. Higher net inflows can be bullish for the dollar and bearish for stocks as they suggest a preference for bonds, while outflows can be bearish for the dollar and bullish for stocks.

MBA Mortgage Applications: A leading indicator of housing market activity, where an increase in applications can be bullish for the housing market and bearish if the demand for mortgages is falling.

EIA Crude Oil Stocks Change: Reports the weekly change in the number of barrels held in storage. A large increase can be bearish for oil prices and energy stocks, while a significant decrease can be bullish.

EIA Cushing Crude Oil Stocks Change: Monitors changes in stock levels specifically at Cushing, Oklahoma; a key hub, significant changes here can indicate broader trends in oil supply.

EIA Distillate Stocks Change: Tracks the change in diesel and heating oil inventories, with a decrease potentially being bullish for energy prices and an increase being bearish.

EIA Gasoline Stocks Change: Measures weekly changes in gasoline inventories, with decreases potentially bullish for gasoline prices and increases bearish.

Philly Fed Business Conditions: It surveys business conditions in the Philadelphia Federal Reserve region; improvement can be bullish for regional stocks, while deterioration can be bearish.

Initial Jobless Claims:The number of individuals filing for unemployment benefits for the first time; rising claims can be bearish, suggesting worsening employment conditions, while falling claims can be bullish.

Philadelphia Fed Manufacturing Index: Similar to the NY index, but for the Philadelphia region, indicating the health of the manufacturing sector.

Continuing Jobless Claims: Indicates the number of people receiving unemployment benefits; increasing numbers can be bearish, while decreasing numbers can be bullish.

Existing Home Sales MoM:The number of previously constructed homes, condominiums, and co-ops sold during the month; an increase can be bullish for the economy, while a decrease can be bearish.

CB Leading Index MoM:A composite of economic indicators that predict future economic activity; a higher index is bullish, while a lower index is bearish.

EIA Natural Gas Stocks Change: Reports changes in natural gas inventories, with large increases possibly bearish for natural gas prices and large decreases bullish.

15-Year Mortgage Rate:The average rate on 15-year mortgages; rising rates can be bearish for housing and refinancing activity, while falling rates can be bullish.

30-Year Mortgage Rate:The average rate on 30-year fixed mortgages; trends here can significantly influence the housing market and consumer spending.

Baker Hughes Total Rigs Count: Indicates the number of active drilling rigs in the U.S., with increases suggesting bullish conditions for the energy sector and potentially higher production, while decreases can signal bearish sentiments.

Baker Hughes Oil Rig Count: A subset of the total count focusing on oil rigs; trends here can impact oil supply expectations and energy stock valuations.