The final week of the month and the quarter is delivering its share of negative US economic surprise, to the extent of moving growth worries nearer to inflation fears—at least in the eyes of the bond market. Fed officials reiterated how inflation remains the top priority, while attaching the ubiquitous disclaimer on the difficulty of avoiding recession. The 7 charts below encapsulate the broadening pullback in bond yields, inflation expectations and gasoline prices. 

The key points of the charts are the following:

1. The divergence between the declining US-JPN 10yr spread and the rising USDJPY, opened the door for an all too likely catch-down in USDJPY to a preliminary target of 134.70s. We told our Whatsapp Broadcast Group to go short near 136.30 earlier this morning. 

2. As the yield on the 10-year Japanese govt bond pulls away from the Bank of Japan's tolerable cap of 0.25%, the central bank is under less pressure to buy JGBs, thereby no downside pressure on JPY, which would help drag down USDJPY and the rest of currencies against JPY.

3. The 3-week decline in US gasoline prices, coupled with falling US Crude oil (partly helped by anticipation of OPEC output hike) is helping to guide inflation expectations lower. 

4. An intensification of the downward trend of inflation expectations may temporarily weigh on metals, but start to serve temporary support for equity indices.

I tweeted yesterday about the considerable drop in the 3-month/10-year spread and its importance in joining the other three popular measures of US yield curve steepening/inversions (2-10s, 2-5s and 3-5s). The crucial aspect with 3-mth/10-yr spread is that by the time it has inverted (10 yr yield below 3 month yield), each of the other three measures would have already inverted. As the 3m-10y drops below the 1st support of 133, the next target stands near 114. Such prolonged declines, would be accompanied with sharp selloffs in the 10-year yield, with which additional declines in USDJPY and rerating of growth and earnings estimates would be inevitable. 

We turn our focus to Friday's release of June services ISM, expected at 54.5 from 56.1. Bond bulls will have a field day in the event of a sub-52 print, or/and a drop in the price paid component below 75. We're not sure about the extent of any rebound in equities due to the challenging earnings season starting next week. Gold, however, should start gaining despite the recession threat to industrial metals. 

 

ماذا يحدث للمؤشرات عندما تبدأ أسهم الشركات التقديرية في الاستقرار بالنسبة لأسهم ضرورات المستهلك؟ هل فتحت الإشارة الخضراء للمؤشرات؟ التفاصيل في هذا الفيديو التفصيلي مع أشرف العايدي

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Is 3500 on the SP500 inevitable? And what's beyond it? Another 4% from here and we reach 3500, coinciding with the 200-week MA as well as the 50% retracement of the rise from March 2020 bottom to this year's high. The relevance of such confluence is further reinforced with NASDAQ100 and DOW30 about 2% away from their respective 200-WMAs. 

As certain as the above analysis appears to be, you have to be careful if you're shorting on leverage. Recall the analysis, flagging the 200-WMA target back on May 12, highlighting the fact breakdowns below the 100-WMA lead to swift continuation down to the 200-WMA at each of the 4 occasions over the past 15 years. There was, however, one slight difference: The break below 100-WMA in summer 2015 was not followed by a break below the 200-WMA until February 2016…and even that was not a break but a “touch”.

Why I bothered to flag that minor exception ?

Simply put, anyone reading that May 12 chart, would have assumed that the break of 100-WMA would imply an immediate resumption of selling down to the 200-WMA. And just as that was not the case in 2015, it was not the case these past 3 weeks. Anyone who had shorted SPX on the week ending May 13t, would have been massacred by a 10% rally in the index, followed by a 13% drop in the ensuing 2 weeks. 

I don't want to belabor the point on moving averages, rebounds etcs, but it is essential warn about these recurring patterns, which may appear valid and powerful, but must be flagged with details and possible diversions. 

So what does it mean for next week?

Next week will lbe business as usual. Bank of Japan gets off with buying more bonds to cap their 10-yr yields at 0.25% at the expense of a 137-bound USDJPY. Fed Chair Powell will testify to Congress on Wednesday, with plenty more time (and less pressure) to convince them inflation is more of a priority for their constituents than tumbling stock/bond/crypto portfolios and soaring mortgage rates.

Speaking of Cryptos, Bitcoin has 3 days prevent a close below its 200-WMA, a moving average coinciding with crucial bottoms and rallies over its 13-year life.   

As tempting as it may be to want go short SPX here at 3685 to target the 3500 (confluence of 200-WMA and 50% retracement), I am anticipating a bounce to start building next week into month-end. This may take us to as high as 4000. If instead, more selling ensues and we reach 3500s, then those who missed the drop, may embark on another bear-market rally. 

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US inflation hit a new 41-year high of 8.6%, bond yields surged back towards their 4-year high of 2.0%, so why gold did rally $50 to $1870? Those who say “gold is a hedge against inflation, therefore gold must rise” are conveniently ignoring the dangers of surging yields to the yellow metal. Remember this time last year, when gold broke down on the mere mention of taper? Now, the Fed has not only ended QE, but is widely expected to raise rates by at least an additional 200 bps this year, not to forget QT (selling the assets it bought 2 years ago). NOTE: if you made money going “long gold” this week you will read this piece differently from those who lost betting against the metal.  That's how the mind usually works. Here is my take on the 3 possible reasons to the rally in gold. 

The 1st reaosn is obvious, the 2nd not so obvious and the 3rd reason needs some thinking.

One possible reason (not the best reason) is that annual core inflation slowed to 6.0% in May from 6.0%, posting its 2nd straight monthly decline. This may not be so significant due to base factors and the removal of surging energy prices. But it may be telling us that inflation is starting to consolidate, when removing energy factors. 

The better explanation for today's surge in metals is what emerged 90 mins after the release of the CPI. The University of Michigan consumer sentiment plunged to a record low of 50.2 in June from 58.4, highlighting people's pessimism with surging fuel prices, broad rise in inflation (food, transports, shelter and health) and tumbling wealth effect from stocks and bonds. When the consumer is suffering at the same time the Fed is expected to raise rates by 150-bps between next week and September, gold traders have to cheer. Why? They're anticipating either a policy error by the Fed (hiking too much forcing them to backtrack on rates), or Fed pausing for an extended period of time. Either outcome, should see inflation peak or pull down modestly, but not as fast the decline as bond yields. Such an outcome would be negative for real bond yields.  

Should we wait for the Conference Board's own index of consumer confidence on June 28, which is so far after next week's Fed decision? Let's see. 

How about a 3rd reason (far from obvious) to the rise in gold? Let's consider breakeven inflation, which is the difference between nominal bond yields and the real yield on an inflation-linked bond (designed to make up for the extent to which the yield exceeds inflation). As gasoline prices picked up fresh momentum two weeks ago, inflation expectations rose across the breakeven curve. More in breakevens here.  

Most specifically, 2-year breakeven inflation has accelerated its pace of advance relative to 10 and 5 year breakevens, highlighting the urgency to which inflation is gaining in the short-term horizon. And so in order to highlight the difference between near-term and longer-term inflation expectations, I plotted the 10-2 inflation spread against gold, showing how the decline in the inflation spread (jump in 2-year over 10-year) feeds into higher gold prices. Regardless of whether the Fed hikes through the autumn or not, gold will stick around for the eventual Fed capitulation. 

1st Positive Signal since April 2020

You must've seen May's monthly charts, highlighting the wild doji candles for the S&P500 and DowJones Industrials30, where the open price for the month equaled the close, with as much as -7.7% and +4.5% intra-month downside and upside respectively. This should fortify the position of both bulls and bears --the former stating the worst is over and we're close to end of Fed hikes, and latter indicating earnings weakness, start of Fed QT this week and inflation pullback being only...transitory).  But, what about the US monthly charts for various USD indices? [Click on the charts to enlarge]

The upper left chart shows the Bloomberg USD index (BBDXY) – a basket of 10 currencies (EUR 32.7%, JPY 14.6%, CAD 11.94%, GBP 11.5%, MXN 9.95%, AUD 5.15%, KRW 3.43%, CNH 3.0% and INR 2.96%). Bloomberg has been (righly) active in pushing their index. It is a more accurate and an increasingly used USD index as far as the greenback's performance vis-à-vis currencies by relevance of their trade relationship with the US. And unlike the Fed's Broad USD index (not included here), the BBDXY is not scattered over too many currencies. 

The upper right chart shows the Bloomberg JP Morgan Asian Dollar Index (ADX), which focuses on the USD's performance versus Asian currencies. NOTE: A rising graph indicates strengthening in Asian FX vs USD and not the other way round. This trading bloc is well known for its disparate economic cycles relative to the US. This means Asian monetary policies often lead the US by 6 or 9 months. The widening (and broadening) role of the Chinese yuan is starting to make the index appear as the China equivalent of the Eurozone mirror image in the case of DXY (see below)

The usefulness of distinguishing the ADX from DXY indices can usually be understood with the help of China's appetite for commodities, specifically metals. This is covered in more detail in a previous post in here 

The bottom chart shows USDX Index (DXY), the most widely traded/followed US dollar index (traded at the ICE). This is a basket of 6 currencies (EUR 57.6%, JPY 13.6%, GBP 11.9% and CAD 9.0% and SEK 4.2% and CHF 3.6%). The heavy euro weighting means the index is largely a mirror image of the euro and little to do with the increasingly powerful Asian currencies. 

What stands out

The lower highs in the Bloomberg USD Index (BBDXY) over the past 5 years capture USD's inability to regain its highs vs the tightening policies of AUD, CAD and MXN. This failure is best highlighted in the May close. Nonetheless, USD bears have little reason to worry as long as 1180 in BBDXY is held.

The deep drop in ADX during April and May was mainly a result of easing initiatives from the People's Bank of China in light of fresh lockdowns and troubled real-estate assets. The stabilization around 102 could appear as a right shoulder support, but more policy guidance is awaited from Beijing.

Finally, DXY is the best performing index of the three due to its significant weighing against the troubled euro (past 4 months). USD bears could point to DXY's failed attempt to close above the highs from March 2020 and Jan 2017, while USD bulls will likely focus on the ability of the April candle (second to last) to close above those highs.

Looking ahead

FX traders focusing on USD pairs need to figure out two things this month: i) to what extent will markets stick to this newfound focus/concern with growth rather than inflation; ii) China's ability to re-open its economy rigorously and restore the supply chain problem. We could add the obvious third factor of Ukraine-Russia war, but at present, the first two will do. The 1st factor can be invalidated once US-10 year yields break (and holds) above 3.0%. This means, once 3% is broken to the upside, inflation concerns would revert as the centre of market attention, propping USD and weighing on indices i.e. bond yields will restore the negative correlation with indices seen so far this year. Thursday's ISM manufacturing figures showed no signs of the slowdown alerted to in this post. In fact, markets are gradualy getting rid of factor (i) and reverting to fully discount a 3rd 50-bp rate hike (in Sept). This month's June FOMC/dotplots/press conference will help in determining odds for a 50-bp hike in September, but as you very well know with 3-months pricing, this could easily change from one week to another to another. 

The latest trades with our Whatsapp Broadcast Group included 3 successfully traded longs in EURUSD, AUDUSD and XAUUSD. The short USDJPY at 127 worked for three days until nearing the verge of being stopped out.