SMU (2023-02-12): It’s All About The Rates
Past Week’s News:
- US: Consumer Confidence (prel) 66.4 (vs 64.9 previous)
- UK: GDP Growth Rate (prel) 0 (vs 1.9 previous)
- China: CPI 2.1 (vs 1.8 previous)
- China: PPI -0.8 (vs -0.7 previous)
Market Sentiment:
A relatively calm week on the economic indicator front. We got a speech from Powell last Tuesday commenting on the strong NFP, and the spirit was that if this trend continues (i.e., strong economic data), then they will have to continue with rate hikes in an attempt to cool off the economy. This has more or less been this week’s narrative from both the FED and ECB, signalling that we should expect higher rates than the markets are pricing at the moment. This has, as I talked about last week, been affecting the markets in the following way: (1) Indices down, (2) Rates up, (3) Stronger USD.
If we look at the Fear vs Greed, we see that it has come down slightly from 93 to 88, which means that it is still high and there is more room on the downside than on the upside.
The SP500 net long has increased 6.5 percentage points, but this should probably be seen as retail traders trying to buy the dip and is not really a directional signal. What is more interesting is the big increase in long EUR / short USD, which has increased by 10 percentage points since last week. Given the higher rates the USD should continue to gain momentum and being short USD at the moment comes with increased risk.
When it comes to indices YTD increase, we can see that the average is 7.5, however, Nasdaq has taken the lead and increased about 13%. If we compare this with the past 200LB, Nasdaq is still in last place with a return of -6%. So, be careful with only looking at the YTD returns, since it is nice to forget the markets’ performance from 2022, it is important to not be blind and zoom out for the bigger picture…
And what is the bigger picture?
As mentioned many times before, I still believe this is a bear market rally, we are heading for/are in a recession, and the markets are most likely going to print new lows in 2023. However, I do not believe that this downturn has started yet and that this rally can continue up until a big catalyst comes, but until then we are going to see a similar pattern that we have seen since October, although it is getting stretched on the upside.
- This Week’s Fear vs Greed 88%
- Last Week’s Fear vs Greed 93%
- SP500 Net Long 43.5%
- Last Week’s SP500 Net Long 37%
- EUR/USD Net Long 59%
- Last Week’s EUR/USD Net Long 49%
- Gold Net Long 63.5%
- Last Week’s Gold Net Long 68%
Indices: 200LB & YTD
Market Update: Indices
Comment: Indices
For indices, we have seen a dip this week that is likely to continue next week as well. From my point of view, this is a normal dip that will bounce back up unless there is some form of negative catalyst (like spy balloons, war, deglobalization, recession, rate hikes, etc, isn’t enough). This dip has been initialized by increase in rates and the fact that the economy is still printing some strong numbers (i.e., NFP), which increases the risk of more hawkish central banks. But, the markets have a short attention span and will shrug this off after the markets have come down and cooled off a little.
What is a likely turning point? I would say somewhere below the mean and close the bottom of the box plot box in the 200LB period graph. Meaning for SP500, around 3800-3950, and for Nasdaq, around 11,000-11,300.
US Sectors & Industries
About sectors, we can see more sectors popping up in the 200LB period. Besides that, the sectors will continue to follow the past pattern and look like this until the catalyst comes. Then, we should see a shift from tech and inflation-sensitive sectors towards more defensive ones.
Market Update: Rates
Comment: Rates
Rates have been the leading indicator this week, which all other markets have been affected by. We have heard a similar narrative from FED and ECB this past week, that the markets have priced the rates too low, and that interest rates have to increase more to be effective in the battle of inflation. This has initiated the cool-off in the main indices, and what we later will see, a stronger USD. We see what looks like a breakout in the 200LB, so the question is how much strength is behind it and how long/far it will continue to go.
Next week, we are going to get CPI for the US, which will determine next week’s outcome for rates.
Market Update: FX
Comment: FX
FX here shows the correlation between rates and the USD. Just like rates increase, we see the USD getting stronger. Something that I think is important to keep in mind when looking into FX and trying to trade a trend, is that FX has no intrinsic value. It is measured by two currencies against each other, and even though there is speculation going on, it is fundamentally driven. Meaning, just because a trend looks negative, or a bottom might be forming, it does not matter if the country decides to increase its rate, etc. An FX pair can rapidly change direction and can go further than one might expect, due to no “fair” value.
The reason I bring this up is the previous mention of the Net Long increase in EUR/USD, meaning an increase in short USD. This is dangerous since this increase most likely comes from retail traders assuming that the trend against the USD is strong, and therefore, buying the dip. But, if something fundamentally changes, like we now see with rates, then the USD is going to get stronger compared to most of its trading pairs, and being short comes with great risk.
On another note, the SEK is one of the few currencies that is getting stronger against the USD due to Sweden’s Central Banks’ increase in its rates in an attempt to strengthen the currency.
Market Update: Commodities
Comment: Commodities
Not much to add from last week’s comment regarding commodities. Gold and metals are cooling off, and likely consolidating to charge momentum for a future increase.
NaturalGas continues to decrease, and CrudeOil is building a bottom. The same goes for Cotton and Wheat, which are still consolidating after the speculative bubble and trying to establish a fair value.
Summary:
- Rates have been this past week’s leading force that has been affecting the other markets. The narrative from the central banks that we should expect higher rates have made the rates break up, leading to a cool in indices, and a stronger USD. Next week’s inflation from the US will be the key factor to determine how this is going to continue.
- Commodities have been continuing the past week’s pattern.
Next Week:
- Tuesday: US: CPI; Euro Area: GDP (prel); UK: Unemployment; Japan: GDP (prel)
- Wednesday: US: Retail Sales; UK: CPI
- Friday: US: Leading Indicators; UK: Retail Sales