Last month, we wrote an article that summarized all the decision made by the US policymakers since GFC and the impacts as soon as the central bank was stepping out of the market (see article Could we survive without QE?)
We concluded that as soon as the Fed was ‘leaving’ the equity market and let it rely on fundamentals only, we saw sharp correction straight afterwards (See chart below: April—July 2010, July – August 2011, September-November 2012).
As we are ‘kindly’ approaching the last days of QE with the Fed stepping out of the bond’s market at the end of this month (October 28th), we thought it is a good time to give you an update on the current situation. And Guess what: this time is not different. Since the mid-September high of 2,019.26 (Sep 19th), the S&P 500 is down 7 percent and closed for the second consecutive session below the 200-SMA for the first time since November 2012. And the question we are asking ourself is: how far it could go? We don’t have a specific answer to that, but what we can tell you is that the Fed’s Officials are now realizing their mistake by expressing themselves on their ST monetary policy. Our thoughts have always been that Yellen [& Co.] should have let the market swallow a period without QE before considering raising its ST interest rate. Therefore, we saw at the last minutes (last Wednesday) a different tone, with policymakers suddenly jawboning about the US Dollar Strength (Yes, even the Fed is not comfortable with a strong exchange rate) and the fact that global slowdown could rise risks to US outlook. We expect the tone to remain neutral until the end of the year, therefore capping the appreciation of the US Dollar against all currencies. If the equity market continues to tumble, we think we can even see/hear a couple of dovish statements/conferences as the equity market is one of the most important index (with oil) for US policymakers.
If we have a look at the LT interest rates, the 10-year US yield is now trading at its 18-month low at 2.20%. Clearly, that shows the situation in the market is much more fragile than expected. Moreover, we added a similar chart as the S&P 500 but this time applied to the 10-year yield. We read and heard analysts’ recommendations on yields, and most of them are quiet bearish on Treasuries in the next months to come, targeting a 10-year yield at 3%. However, if we look at the chart below, we can see that each time the Fed stepped back of the bond market, LT yields contracted (March – November 2010, July-September 2011). And it looks like this time is [also] not different with the 10-year yield down 80bps since December’s Taper Announcement.
This week has started with limited risk appetite as situations in Iraq and Ukraine both remain intense. US yields still struggle to take off in the middle of this QE Taper environment (10-year is trading below the 2.60% level), while Gold and Silver both continue to soar and are now trading above 1,300 and 21.00 levels respectively. The US Dollar remains offered against most of the G10 / EM currencies; as you can see it on the chart below, the USD index continues its bearish momentum and is now trading at 80.23 between its lower Bollinger Bands (20, 2.0) and its 200-day MA.
Dollar Bloc: Low vols sustain demand for Dollar Bloc currencies and especially the Canadian Dollar. Since its high of 1.1278 on March, USDCAD has entered into a bearish momentum as the Loonie continues to benefit from higher than expected CPI figures. As a reminder, annual inflation came in at 2.3% in May (vs 2.0% consensus) and stands now above the BoC 2-percent target. USDCAD broke its 200-day (1.0783) last week and visited its 5-month low at 1.0710 earlier this morning. The next support on the downside stands at the psychological 1.0700, followed by 1.0650 (Jan 7).
Yen: Low US yields in addition to a quite Japanese overnight session add pressure on USDJPY, still trading below 102.00. The pair has been stuck within a 70-pip range for the past couple of weeks, trading above its 200-day MA (101.65) and below its 100-day MA (102.20). The pair’s vols stands at their lowest level; the 1-month ATM volatility decreased to 5.02% (from 10.2% in the beginning of February). USDJPY looks vulnerable and we would carefully watch the downside at the moment; a break of the 200 MA would push the pair back to its strong support at 100.75. On Friday, we will get an update on inflation and household spending figures in Japan; Core Nationwide CPI is expected to increase to 3.4% in May (up from 3.2% the previous month) and could continue to disappoint investors on the easing measures (no signs of urgency from BoJ policymakers).
Euro: We expect the single currency to come back under pressure in the medium term as it seems that the ECB is not done with easing. Final Inflation came in at 0.5% YoY in May a couple f weeks ago and flash EZ Mfg. PMI printed below expectations of 53.5 at 52.8 (French Mfg. PMI was miserable at 47.8). Traders will watch closely updates on Inflation (flash) and ECB figures (Private loans and Money Supply) next week on Monday. EURUSD is trading back above 1.3600; the next resistance zone is seen between 1.3660 (higher Bollinger Band) and 1.3670 (200-day SMA).
Sterling: After Carney’s hawkish comments at the Mansion House that the BoE will consider raising its Official Bank Rate (currently at a historical low of 0.5%) sooner that the market expects (which meant Q1 instead of Q2 previously), today’s testimony before the Treasury Select Committee sounded a bit dovish. BoE Governor said that the ‘exact timing’ if a rate increase will be ‘driven by the data’ and will be ‘limited and gradual’ based on the central bank’s estimation. The 2-year UK-US yield spread shifted lower to 41.1bps this morning (down 4bps), bringing Cable below the 1.7000 level. There has been a large build of long Sterling positions for the past few weeks based on monetary policy divergence (long GBPCHF, GBPJPY or short EURGBP are popular positions to hold at the moment), and the dovish stance of this morning may be another good opportunity to enter (buy on dips / sell on rally) for traders or investors.