Dollar Index – A bullard in a China shop
Federal Reserve official James Bullard became the proverbial bull in a China shop on Friday when he said that the Fed might need to raise rates in late 2022 instead of 2023. That sparked a run for the exit door for equity markets and commodities while the US Dollar powered higher. The US yield curve continued to flatten as long-dated bond yields slumped, notably in the 20-year tenor.
The major casualty has been the global reflation/cyclical recovery trade. The reaction of markets since the FOMC dot-plotted everybody last week indicates how much cash was in that trade. Equity markets in Asia are following Wall Street South in Asia today, notably, Japan, which is down nearly 4.0%. I can’t see any particular reason for Japan taking the bearish gold medal today, other than it has a very high retail FOMO level of participation. Tokyo markets are probably hanging out for the Bank of Japan to reappear and buy stock ETF’s aka China’s “national team.” They have been disappointed so far.
The US Dollar has been the big winner post-FOMC as those reflation trades were unwound, and firmer short-term rates will likely continue to support the greenback. The Fed itself slipped a couple of liquidity measures into the latest FOMC, which I suspect may also be exacerbating the great reflation unwinding.
The Fed lifted the rate it pays on bank reserves (IOER) to 0.15% and raised the rate it pays on overnight reverse repurchase agreements from 0.00% to 0.05%. That was because the effective fed funds rate banks lend to each other out was in danger of turning negative thanks to the sheer amount of capital sloshing around in the system. One thing I like about the Fed is they hate negative interest rates, one of the most counterproductive and moronic tools deployed by central banks who have run out of ideas elsewhere.
Since Wednesday, reserves held at the Fed have rocketed by $235 billion to around $755.0 billion. Yes, you read that right. In a zero per cent world, five basis points of risk-free money is an irresistible lure. The net effect is that the Fed is draining some cash from the system at the short end, even as it quantitatively eases further out the curve. That might explain some of the US Dollar strength and the run for the exit door everywhere else.
The unwinding of the global reflation trade still has some way to go in the sessions ahead, I believe. It’s a volume thing, and a lot of water needs to drain through the spillways yet. It is too soon to say whether this is a painful correction or a structural turn in the buy everything trade. Data prints of late globally suggest the recovery is on track, but expectations have been running ahead of reality for a while.
However, if it continues, we may see an overdue reckoning for some of the dumber investment decisions being made by investors searching for yield in a zero per cent world—high yield credit and SPACs for a start. The recent rush of Asia tech companies to announce SPAC floats in the US at ridiculously pimped-up valuations could come to a grinding halt. Virtual currencies may feel the heat and meme-stocks, although I wouldn’t bet against the outlaws of Sherwood Forrest continuing to take from the rich and giving to the rich on the other side of the trade while possibly remaining poor themselves. If investors starting asking aspiring IPO/SPAC companies, are you profitable? Do you have a path to profitability in my lifetime? Or is this just a way for early investors to cash out? The world will be a better place.
The data calendar this week is relatively quiet. China has left its one and five-year loan Prime Rates unchanged already this morning, which was one of the weeks highlights. The US releases Personal Income and Durable Goods at the end of the week, and if they are soft, that reflation unwind may get a second wind. The Bank of England has a policy decision on Thursday, but with one eye on the delta variant cases in the UK, they will hold fast with an outside chance to start talking about starting to talk.
With no data to distract markets, they will move on positioning and sentiment, which is decidedly negative as the week begins. Another reason to believe the great unwind will continue at pace. The usual plethora of Fed speakers will be closely watched and generate more volatility than usual in the information vacuum after Mr Bullard’s efforts on Friday. He is speaking again tonight as well. Expect the word “whipsaw” to appear in the literature this week.
Finally, being Monday, and because so many readers ask me about it, it is the weekly paragraph on Bitcoin time. Having invalidated the bearish symmetrical triangle earlier last week, Bitcoin faded ahead of $42,000.00 of taxpayer revenue-baked US fiat currency Dollars last week. The charts are not very clear this week, but this week’s support levels are $31,500.00 and $30,000.00. If, as I expect, the global buy-everything unwind continues this week, Bitcoin will feel those chill winds as well. I am, of course, a perpetual mega bear anyway, but someone must balance out those experts appearing on tv in tee-shirts, surrounded by pizza boxes and computer monitors shouting, “you don’t understand.”
Equity markets in Asia head South
The Bullard comments on Friday were all the excuse Wall Street needed to send a very long and wrong market South. Much the same pattern is occurring in Asia today to greater or lesser degrees. Mr Bullard is a well-known hawk regarding monetary policy, and the reaction to his comments on earlier rate hikes highlights the degree of nervous positioning out there.
On Friday, the S&P 500 finished 1,31% lower while the Nasdaq fell 0.92%. The Dow Jones suffered most of all, tumbling by 1.58%. Relatively speaking, the Nasdaq has held up relatively well as investors cycle out of growth stocks on the S&P 500 and Dow Jones and into the perceived safety of big-tech. Notably, futures on all three indices have continued retreating in Asia. The S&P 500 e-minis and Dow futures are 0.60% lower, while the Nasdaq futures are just 0.25% lower in a repeat of Friday’s price action. Banks, energy, commodities, and consumer discretionary were all underperforming sectors with a flattening yield curve lousy news for future bank profitability.
In Asia, the Nikkei 225 has tumbled by 3.50%, easily the worst performer of the day. I suspect that market heavy with nervous retail investors is behind the relative underperformance, with no sign of the BoJ entering the market to buy ETF’s, their usual backstop. The Kospi has fallen by 1.20%, while in Mainland China, the Shanghai Composite is down just 0.25%, while the CSI 300 is 0.60% lower. Investors there no doubt expecting China’s “national team” to smooth proceedings.
Hong Kong has fallen by 1.50%, with Singapore down 1.25% and Taipei 1.50% lower. Kuala Lumpur has retreated by 1.10%, with Jakarta down 0.90%, and Bangkok is falling by 1.30%. Australian markets are also experiencing a torrid day, as banks and resources lead markets lower in another retail sentiment dominated market. The ASX 200 and All Ordinaries have tumbled by 1.85%.
European markets are unlikely to buck the trend this afternoon and given that they are very much orientated towards global recovery plays, they could well underperform most of Asia.
The move lower in stocks still looks corrective to me. I suspect the falls are primarily a function of financial markets being very long the global recovery trade. Interest rates are going nowhere fast, and the world’s central banks have not closed the liquidity spigots. That said, the unwinding still has plenty of juice in it, and this week could be a tough one for equities unless some of the Fed doves hit the newswires in force.
The US Dollar rally continues
US 10-year and 30-year yields have moved sharply lower in Asia this morning, but that has not dented the US Dollar strength that continued on Friday. The dollar index edged 0.04% lower to 90.28 in Asia, having recorded a strong 0.46% rally on Friday. That left the dollar index 2.0% higher for the week. With momentum clearly favouring unwinding the global reflation trade, the dollar index could extend its rally to the 93.00 area in the early part of this week. I do note, though, that the Relative Strength Index (RSI) has hit overbought levels, suggesting that Asia and Europe may trade sideways today.
EUR/USD fell 0.36% to 1.1860 on Friday, where it remains in Asia. It is now well below its 100 and 200-day moving averages (DMAs). It has the potential to test 1.1800 and 1.1700 later in the week. GBP/USD fell 0.86% to 1.3800 on Friday, as greenback strength and nerves over the Covid-19 delta variant combined to weigh more heavily on it. The close well below its 100-DMA was an ominous technical development, and GBP/USD could target support at 1.3675 if 1.3800 comprehensively fails.
The Australian and New Zealand Dollars, being barometers of global risk sentiment and significant beneficiaries of the worldwide recovery trade. Both have now comprehensively fallen past their respective 200-DMAs as of the Friday close. AUD/USD has climbed 12 points to 0.7490 this morning but could potentially extend losses to 0.7250 in the coming week. Similarly, NZD/USD is trading at 0.6955 today and could target 0.6800 and 0.6700.
Although the overall picture suggests more US Dollar strength versus the majors, most have entered oversold territory versus the greenback in the shorter term. That could see some recovery today by EUR/USD, GBP/USD etc., but that is probably a rally to sell into and not a bottom-fishing opportunity.
USD/JPY Has peaked near 111.00, falling back to 109.80 as of this morning. The key driver has been the flattening of the US yield curve, highlighting once again that USD/JPY these days is a yield differential play. With that in mind and watching US bonds rally once again in Asia today, USD/JPY is a sell on rallies to 110.00 and could fall as far as 108.50 this week.
USD/Asia is rallying across the board today, with the KRW, NTD, THB. PHP and IDR all weakening, some by as much as 0.50%. There is an element of catchup involved as most of Asia has restricted liquidity in offshore markets. Thus, the rally in USD/Asia today isn’t necessarily indicative of another bout of US Dollar strength, although USD/Asia will likely be a buy on any dip this week.
Notably, offshore Yuan, the USD/CNH has risen above its 100-DMA this morning at 6.4690, and a daily close above it would signal more weakness for CNH, with USD/CNH trading at 6.4790 today. The PBOC set a weaker than forecast Yuan fixing onshore today at 6.4546 while adding CNY 10 bio in liquidity via the 7-day reverse repo. It seems the PBOC is using this bout of US Dollar strength to squeeze out further USD/CNY and USD/CNH shorts, having subtly signalled that Yuan strength had gone far enough a couple of weeks ago. That will also keep Asia FX on the back foot, and both USD/CNH and USD/CNY have comprehensively broken out of 3-month downtrends as of last week.
Overall, the overbought technical indicators on the US Dollar across the board could see a pause and perhaps a modest retrace of Dollar strength in the 24 hours ahead. However, in the grander picture, US Dollar strength is set to continue until a lot more global reflation positioning across asset classes is culled.
Oil remains immune to US Dollar strength
Oil has risen this morning in Asia after Iran elected a hard-line President over the weekend. That puts any breakthrough in Iran nuclear deal negotiations in further doubt, removing some of the risks that Iranian crude will return to global markets officially, anytime soon. Adding to the supply-side risks, the interim nuclear deal extension with world powers is due to expire this week.
The Iranian election seems to have supported oil prices on Friday as well, with Brent crude rising by 0.30% and WTI climbing 0.50%. In Asia, Brent crude has rallied another 0.63% to $73.70 a barrel, with WTI jumping 0.68% to $71.90 a barrel.
Despite the culling of global recovery positioning evident last week across multiple asset classes, oil’s underlying physical demand picture remains positive. Despite the noise in financial markets, the real world is on the right track and will require increasing amounts of energy as it reopens. That is evidenced by the backwardation in the oil prompt futures curves. If anything, after markets elsewhere have corrected, lower interest rates should support oil prices, and more so if Iranian crude is not returning to global markets anytime soon.
Having weathered the US Dollar storm last week, Brent crude should remain a buy on dips to $72.00 and $71.00 a barrel. Only failure of $70.00 a barrel tilts the medium-term technical picture to the downside. Initial resistance is at $75.00 a barrel. WTI should find support on any dip to $70.00 a barrel, and as long as $68.00 a barrel holds fast. Resistance lies at $73.00 a barrel.
Gold holds support finally
Gold had a volatile session on Friday, trading a nearly 40-dollar range between support at $1760.00 an ounce and resistance and the 100-DMA at $1799.00 an ounce. It finally finished the day down 0.52% at $1764.00 an ounce. However, in Asia, it has retraced all that loss, rising 0.50% to $1773.00 an ounce.
Notably, gold held onto critical support at $1760.00 an ounce on Friday. That is important because the daily RSI moved into severely oversold territory on Friday. This morning, it has staged a minuscule recovery today, but is usually an excellent indicator of impending counter-trend corrective moves.
That means that in the near term, support at $1760.00 should remain intact and that gold can stage a recovery from here to unwind the oversold RSI. That rally could once again extend to its 100-DMA at $1798.00 and the resistance line at $1800.00 an ounce. However, overcoming this resistance zone will be challenging if intense US Dollar strength persists elsewhere. Despite golds, performance today, any recovery rally above $1780.00 an ounce looks like a selling opportunity rather than a bottom fishing one.
Dollar Index – A bullard in a China shop
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