Tiny Bubbles
“When I buy a new book, I read the last page first. That way, in case I die before I finish, I know how it ends..”
—When Harry Met Sally
China had a good year last week.
Key takeaway: China equities exploded higher but the price profile in the U.S. was capped, despite new highs. Bowman may be in the minority, but she may be right that the FOMC may have dismissed inflation too early. The choice for Japan’s new PM just ushered in Yen volatility. U.S. investor outflows warn of a bond market top. High Yield spreads to Treasuries are diverging from S&P 500 index highs. Crude Oil may be the best indicator to gauge the success of China’s stimulus.
Build It and They Will Come Dept: We just saw a good example of my Variable Dimensionality framework. China took some major stimulus steps this week, placing China’s efforts to promote growth as one of the top three market drivers. Until it falls out of the top three, it is bullish global risk assets and commodities. The long-term issue is whether this stimulus cultivates true demand, or just generates a bid in equities. Adding liquidity that no one wants (other than for stock speculation) is not a solution. The reality is that the country is facing enormous problems spanning infrastructure and foreign direct investment, a property market that even local governments are shying away from, and a failing consumer, to name just a few.
The big deal for markets is that first, China’s securities regulator has incentivized banks to take on 2.25% loans for buybacks. Second, these loans are also available directly from the People’s Bank of China (PBoC) to banks, brokers, and insurance companies to lever their stock purchases. This type of leverage has a painful history: the increasing mortgage-backed leverage assumed by U.S. financial institutions in the run-up to the housing crisis turned into a major financial crisis.
Comparisons to 2008 are alarmist and premature, although the potential exists for an overleveraged Chinese financial sector. If the market begins to fear that in trying to fix the property crisis, the government is exposing the economy to a mini-2008 GFC, then credit spreads widen and bank valuations reverse.
Be careful what you wish for: The festering problem is if this mini bubble continues, the less pressure is on Beijing to address the real issues. That means that the total bailout required will grow enormously if the crisis gets to the point of no return. Additionally, so will the leverage gearing at the banks.
For now it’s Party On, but the fact that the jubilation did not cascade into our markets is something to look out for.
Currency War: China vs. Japan
In October 2020, the Chinese Yuan began appreciating to the Japanese Yen as seen by the blue arrow in the CNYJPY weekly chart below and continued higher into Q3 2024.
It is important for the Yuan to depreciate to begin to help stop the general deflation in China, and to help push even greater export volume. Moving below cloud support (red arrow) will help the trend reverse. That would be a welcome event, along with a weaker Yuan versus the U.S. Dollar.
Copper
In addition to following CNYJPY, I mention below to watch crude prices to signal whether China’s stimulus measures are taking hold. One more indicator that their actions are putting a floor under their property sector would be if copper can continue to rally.
The weekly copper chart from the March 2020 lows displays last week’s outsized rally with the large green candle.
I included two other instances of even larger green candles highlighted by the red rectangles. Commodities often hit a buying climax to top out a rally. I will be watching copper futures closely this week to see how demand for the metal follows last week’s move. An extended move that fails would be a warning sign.
Something to Consider into Friday’s Nonfarm Payrolls
Here is the Conference Board’s Labor Differential (Jobs Plentiful - Hard to Get) for September, displaying an accelerating deterioration:
Next month it will be important to see if the Fed rate cut improved the labor market outlook. For now, it is positive that the current level is at the 2006-2007 highs (see red highlights), but the clear negative is the cascade down that resembles the outset of a recession.
This chart reflects our worry about the decline in the jobs market and was a factor driving the September Present Situation Index (consumers’ assessment of current business and labor market conditions) down 10 points and near its two-year low. Unsurprisingly, given that people have spent their pandemic savings and loan delinquencies are on the rise, consumers earning less than $50,000 saw the largest drop in confidence.
Not included in the overall confidence calculation is consumers opinion of their Family’s Current Financial Situation, which hit its worst level in over two years.
Stag: Regional Fed Surveys
The Kansas City Fed Manufacturing Index showing manufacturing has been declining for two years:
The Richmond Fed Manufacturing Composite Index, a 3-month average diffusion index (those surveyed who find their business expanding less those whose business is contracting) is not exactly thriving either:
The Richmond Fed Manufacturing Employment: the 3-month moving average diffusion index is matching the pandemic lows.
‘Flation: Stirring Under the Covers
Dallas Fed Trimmed mean PCE came in at the lowest level in three years at 2.67%, after being near 5% from Q3 2022 to Q2 2023. It is trying to fall below the 2001 and 2006-2007 highs (see red line below).
The continuing drop supports the FOMC’s complete lack of worry about upside inflation risks. However, if they were to look at the percentage of high inflation items above 5% in the Personal Consumption Expenditure Price Index from the Dallas Fed below, they may think twice. High inflation is sticky, and moved up to 30%, near the April 2024 highs (note the lower red horizontal line at 30%).
I added another red horizontal line near 70. There are now 31% of all PCE subcomponents that are deflating at an annual rate. There appears to be a U-shaped dynamic going on when you distill the different inflation categories of PCE. Both the high and low inflation components are increasing. The overall inflation path is downward, thanks to an increasing number of items with a negative annual price rise, but sticky services inflation needs to be watched, especially after the Fed’s 50-basis point cut.
Governor Michelle Bowman, the lone dissenter to the Federal Open Market Committee’s (FOMC) 50-basis point cut shares my sticky inflation concern. She mentioned in her speech last week,
In my view, the upside risks to inflation remain prominent…and [as to our] dual mandate, I continue to see greater risks to price stability.
Note that in the following quotation she says progress on inflation “could continue to stall”, which underlines her belief that core PCE holding above 2.5% means inflation is stalling, not falling.
Expansionary fiscal spending could also lead to inflationary risks, as could an increased demand for housing given the long-standing limited supply, especially of affordable housing. While it has not been my baseline outlook, I cannot rule out the risk that progress on inflation could continue to stall.
Therefore, Michelle Bowman is worried that by cutting 50 basis points prematurely, the FOMC could be inflating the upper end of that U-curve of high-inflation PCE components and guaranteeing that sticky inflation stays that way.
Bowman’s Concerns Materializing: What if the One is Smarter than the Other Eleven?
While Fed Governor Michelle Bowman wanted a more gradual approach, she was relieved that Chair Powell tried to contain investors’ expectations. However, as it turns out, her worries were well placed. When explaining her dissent, she said,
Reducing the policy rate by 1/2 percentage point could have led market participants to expect that the Committee would lower the target range by that same pace at future meetings until the policy rate approaches a neutral level.
Despite Powell’s comments during the press conference, futures markets are pricing in one 50 basis point cut and one 25 basis point cut to end the year, with a 30% chance of cutting “by that same pace” at both the November and December meetings. She warned that if that were to become the market consensus, then,
An unwarranted decline in…broader financial conditions could become overly accommodative.
The problem is that Bowman did not view the 5 ?% - 5 ?% peak Fed funds target as ?restrictive because her estimate of the neutral rate is high. There is a massive range of forecasts for the neutral rate, and the September Summary of Economic Projections has it at 2.4%-3.8% among the 19 FOMC participants. If she is the highest at 3 ?%, then by December we could be sitting on top of Governor Bowman’s long-run Fed funds target if the 30% of investors expecting two more 50-basis point cuts are correct.
The markets need to start focusing on how even easier financial conditions could be setting markets up for a mini bubble.
The markets will be adjusting their view throughout this week with the JOLTS, Challenger Job Cuts, the ADP Employment Report, Initial Jobless Claims, and ending with Nonfarm Payrolls Friday. My bias is for more weakness, but downtrends are not always straight down.
Japan: Political Chaos…Eastern Style
Below is a 5-minute chart of USDJPY, which looks as though the Bank of Japan Intervened on the morning of September 27.
However, it was just the breaking news that the new Liberal Democratic Party (LDP) chose Shigeru Ishiba as Prime Minister. The spike up just before the collapse was on news that Takaichi, who is opposed to the BoJ’s desire to raise rates, was the front runner. Ishiba supports the BoJ’s efforts in normalizing monetary policy, which generated the spike. The Nikkei also fell on the news, after the temporary Takaichi spike. It remains to be seen how long he will stay in power within the LDP, assuming he survives the October 27 general election against former PM Noda. A poll released today puts Ishiba at a 52% favorability rating. Get ready for currency volatility.
End of the Yen Carry Trade?
Ishiba wants a clear break from Abenomics, which was created to pull Japan out of its deflationary spiral with the three arrows. That meant increasing the money supply to depreciate the Yen and make exports more competitive, big fiscal spending programs to stimulate demand and consumption (what China should be doing now) and putting in place major regulatory and corporate reforms. The concern is that this can mark the end of the Yen Carry Trade, but aside from promoting a more inward-focused Japan where he is an advocate for onshoring production, his economic platforms are vague.
He will advocate for a more neutral policy in his diplomacy between China and the U.S. which will put him at immediate odds with the new U.S. president next year.
BoJ Minutes: The Bank of Japan’s Chairman, Governor Kazuo Ueda’s Summary of Opinions comes out Tuesday for the September 26 Monetary Policy Meeting. After reading the full minutes released Thursday, I am looking for some of the more hawkish elements to be stressed after Ueda edits comments coming from all members of the Monetary Policy Board. One member was ready to raise rates at the September meeting. A clear theme emerged that real interest rates were at their most negative levels in 25 years, so that even when they raise rates again, it still reflects a very high degree of monetary accommodation, meaning there are more hikes in the pipeline.
Four items in the minutes would be insightful if they survive Ueda’s edits and are featured in his Summary of Opinions:
This final concept is critical, and I especially will look for how Ueda treats it in his Summary. The following is sure to be included: “if the outlook for economic activity and prices was realized, it would be appropriate that the Bank accordingly continues to raise the policy interest rate and adjust the degree of monetary accommodation.” They are not sitting at 0.25% interest rates unless the economy slows sharply.
Bitcoin Update
Bitcoin is back to channel resistance for the third time and left a tail, indicating initial rejection, once more (see three arrows).
领英推荐
This week will be an important test to see if the trend channel holds.
Markets:
Equity Market: 5 different time frames: 5710 +/- 15 point support region for S&P 500
Weekly Trend: Bullish
Shortest view: 30 min SPY—sell below 5725 for a trade
This is an elongated version of the 360-minute futures chart just below this chart.
The support line and parallel channel intersect along with a swing low at 5725 in the S&P 500 in cash. There could be a failed breakdown that reverses strongly, but if there is a sustained break it could start a much larger unravel.
360 min ES 5775 in futures
I like to break the day up into four time zones, and this Emini S&P 500 chart shows clear buying at support:
Each test of support weakens the demand, and we opened below to clear out stops, and that level remains key (down to 5772) tomorrow, and it rises gradually throughout the week. Large sales should come on any sustained break and could constitute a major trend change.
Daily: including opening Sunday levels in futures
The models should coincide with a red bar (flip on daily trend model to a sell signal) with a break of the 5750 region in futures (5695 intraday in SPX cash) as a robust sell signal. Otherwise remain bullishly positioned.
Weekly: We got our small range
I wrote last week: “In the case of a small range week by the close on Friday, I start positioning for a selloff.” The range was only 68 points, a little over 1%, or about 1/3 of the typical weekly range for the past quarter. Therefore, a break below last week’s 5710 opening, and certainly below last week’s 5699 low confirms a good risk return setup for a trader, with a stop either above the 5738 close or the 5767 high.
These are weekly levels, so use daily closing levels and size accordingly.
The long ball: SPX monthly resistance levels
Cluster of resistance at 5755 versus the 5767 high and Friday’s 5738 close.
Upper extensions target 5800 plus or minus 20 points. At that point, the air gets thin.
Equality Rules—Weekly RSP
The equal-weighted S&P 500 Index ETF RSP has maintained over the 176 former resistance level for two weeks. As I mentioned two weeks back, above 176 and the path stays open to 6000 for the S&P 500 cap-weighted index.
A break below 176 is a good first sign of a reversal, with confirmation below 170 and 168 in the weekly timeframe.
Fixed Income: Door Dash
Weekly Trend: Bullish / Overbought and nearing reversal
Unusual Outflows
Bank of America reported the largest outflows for the year in Treasuries. The last time the 4-week moving average (see dark blue line) of investor Treasury flows went negative was last December, when bond prices peaked.
The chart below shows the weekly 10-year yield chart with my momentum buy triggers for yields/sell in price (blue triangles) and a filter line in black going back to Q1 2022. The December 2023 setup resembles today (see green annotations):
A clean sell signal for bonds will occur on a move above 3.79% for 10-year yields. The 3.75%-3.80% region is a significant inflection point. If China is going to solve its deflationary and growth problems, global bond yields should spike. Watch for a move above 3.80% in 10-year notes, which would also support Michelle Bowman’s concerns of an FOMC that is not worried enough about inflation.
High Yield Red Flag Revisited
ICE Bank of America High Yield Option-Adjusted Spreads dropped since the FOMC (see red arrow) but have kept the rounded bottom formation pointed out last week.
The rounded bottom formation continues to follow the late 2021/early 2022 analog when the major stock indices made strong reversals from all-time highs that resulted in a 10-month selloff. This divergence resonates with the labor differential in the earlier section continuing to fall.
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China 10 yr government yields—a critical chart to monitor
I displayed this chart last week of Chinese yields, and given the strong turnaround it is important if it continues.
A reversal that is more than a short covering reaction would constitute a key change because it would signify that investors believe in a Chinese recovery, much the same way that during our financial crises, the bond market gives a ?green light that signals when fiscal measures are sufficient, and the yield curve steepens.
However, the stimulus may be lacking if we consider 3.1% real yields (2.20% nominal yield less -0.9% deflation). That is an argument in favor of QE, but there is nothing forthcoming. We have indirect QE with the PBoC financing equity investment, but that could end up being just a band aid.
Crude Oil: Look to Crude as a China Growth Indicator
Weekly Trend: Bearish but oversold
Saudi abandons $100 per barrel price target: The big news happened on Thursday: Saudi Arabia is considering abandoning their unofficial $100 per barrel price target for crude as it may ramp production to increase its market share. OPEC+ said Thursday that they intend to go ahead with December’s oil output increase. The OPEC+ news caused many analysts to drop their WTI crude forecasts into the low $60 range for next year.
On Wednesday, the Dallas Fed released their Energy Survey for September, which concluded that the oil and gas industry is in a tough situation throughout the oil patch. The headline business activity index flipped negative for both exploration & production firms and services firms in Q3, driven down in particular by contraction among services firms. The company outlook index also turned negative for Q3,and the overall outlook uncertainty index jumped.
WTI crude basically stayed within last week’s range, so I will feature a daily futures spread chart. The front month continues to trade above the back month, although it is trading at a small premium (I am spreading January to October for a 9-month spread in 2025)
For now, there is minimal near-term demand, and spreads are approaching the December 2021 lows when crude bottomed below $65 (spiking momentarily to $62.50).
Oil forecasts have fallen due to China’s forecasted low energy demand. Now that the stimulus has arrived, if China’s economy gets back on solid footing, crude prices should respond. If the stimulus is once again misdirected, and going to result in just a short covering equity rally, then crude will stay below $75, and my daily model will not flip to positive.
Best,
Peter Corey
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