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US dollar break out, US economic strength, the Fed, Oil, and EM – McKenna Macro Markets Weekly

on April 27, 2019

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Key Takeaway

US earnings and the 3.2% Q1 GDP print Friday are doing a great job of reinforcing the message I have been belting since last year. The US economy is in better shape than the market had priced and the hand wringing doomsayers are early – which is as bad as being wrong.

Now don’t get me wrong, I’m not always right, and not in the never wrong club. But anyone with more than a passing interest in the Australian economy over the past decade knows that a cautious and patient central bank with a strong jobs market can extend an economic expansion further than pundits expect.

And if or when needed it can cut rates too.

We saw the fruits of the Fed’s policy of patience and economic strength this week in a higher USD and still solid stock markets. That’s the story of the week.

The Week That Was…

Now for the week ahead, let’s dive in.

Key Themes driving markets

US dollar break out

It was looking like a bang Thursday, but the US dollar’s break out ended the week with a bit of a whimper given it just held onto the important 98.00 region I have been looking for and just below the 1.1165 region in the Euro.

USD Index (DXY) weekly

That’s not to say I’m not bullish the Greenback. regular readers know that I’m both a structural USD bull and have been looking to a broad break out which included the USDCAD, USDSGD, and USDCNH as confirmation of the USD move.

We had that Thursday but we didn’t have that at week’s end. Indeed USDCAD reversed back into the range at week’s end to finish at 1.3453, USDSGD closed at 1.3617, and USDCNH ended the week at 6.7394. Close but no cigar.

Not yet anyway.

Perhaps the resistance at 98.60/80 in DXY terms and 1.1060/70 in the Euro is the real levels to watch. That’s not to say I’m not bullish or long for that matter because I am. And structurally we’ll be talking about 1.03/04 at some point for the Euro and DXY 104 which will then have knock on effects for EM and other currencies – and might finally get the Aussie dollar down to a level it will assist economic growth.

For now these are the levels to watch and buying any USD reversals is favoured given the differing economic and thus policy positions

EURUSD Weekly – TradingVIew

3.2% Q1 GDP poses a problem for a dovish Fed

Okay, so you wondering what coolaid I’ve been drinking to say that the Fed is in a different spot to other central banks given it was the first to make a super aggressive pivot back toward dovishness. But the reason I say this was that the Fed’s move seemed more expedient than reflecting real concerns about the economy.

I say that with reference to the many speakers we’ve heard over the course of this year who noted the cautious stance was the correct one but who on balance who have iterated time and again that teh Fed’s take on the economy is that it is stronger than the market had priced with the deep dive last last year.

It’s as if the Fed knew it had to quieten startled market horses but equally last years big collapse in stocks and other markets was more about liquidity and holiday thinned markets than anything underlying in the real economy.

Now I know the rusted on bears will be shouting at your screens and telling me the 3.2% annualised GDP was all about inventories and thus can be taken with a grain of salt.

US GDP and Retail sales both lifting – TradingEconomics

To that all I say is simply this – you can usually always deconstruct a number to find what you are looking for. But the reality is a strong jobs market, recovery in retail sales, and Fed pause have combined to give this recovery a good chance of extending beyond expectations of the bears.

But don’t listen to me listen to the CEO’s of the big balance sheet banks – JPM, BoA, Citi – they don’t see the recession.

So it is going to be an interesting statement and press conference from the Fed this week. Jay Powell won’t want to scare the horses but with jobs where they are and BoA saying north of 250,000 is possible for April non-farms he’ll likely radiate positivity about the economy outlook. And with low inflation he’s got no need to move on rates anytime soon

Stocks still making records

Of course earnings not as bad as feared and beating expectations, solid jobs, and growth, low inflation is really a very sweet spot for a bull market in stocks. As I wrote in my daily last week I’m leery of where Chinese markets are going with signals no more stimulus is coming.

Likewise I’m leery of what the moves in oil, bonds, and gold suggest right now. What are they seeing that no-one else is. I’m not sure, but I am watching the price action in these markets.

For the moment though the rally continues in stocks – US and elsewhere. The Dow has stalled but the Nasdaq and S&P are making fresh highs while the ASX 200 and DAX are also doing well.

S&P 500 futures Weekly – TradingView

Looking at the S&P on the daily you can see it struggling a little. But on the weekly the JimmyR trend indicator is still pointing higher.  Though I note both the vertical angle of the gains – which is a warning – and the level of the stochastic indicator which too suggests overboughtness.

The question is whether the market keeps going straight up or we get a move back towards support 100, maybe 150 points below current prices. That would suggest a move back toward 2800 and for me that is a big chance in S&P terms.

It would thus impact other markets as well.

Tweeter in Chief helps Oil collapse…

One of the big worries for USD bulls will be the reality that the interventionist President Trump will wake up one morning and tweet something about wanting a lower US dollar. Certainly we know he’s done it in the past and we know that even with 3.2% annualised GDP growth in Q1 his economic advisor Larry Kudlow is still calling for the Fed to cut rates.

So I have little doubt that day will come.

Just like it came for oil prices Friday when the Tweeter in Chief said he “spoke to Saudi Arabia and others about increasing oil flow”.  That igniting a wave of selling in oil futures which, while it fit the technicals may suggest that a high for this run is in.

Source: Twitter

Indeed my system went short on the break of Thursday’s low around $64.90. And to me the price action looks like it has further downside to go with tentative targets at $60.90 (76.4% of the up move and bottom of the Bolly bands). Below that $57.40 comes into the fray.

WTI (CLc futures terms) Daily – TradingView

But there are many Elliott Wave folks out there who believe the move lower will be more substantial and structural in nature. Certainly the weekly candle for WTI and Brent looks ominous and one of the best EW proponents on Twitter – Steve Henderson @TTCSteve – suggests this in a tweet Saturday.

Source: Twitter

What’s important about this is the impact oil prices, assuming they do drift lower, will have on high yields markets and perhaps on stocks too. It is my contention that the weakness in oil last year was a big part of the market funk at the time – leading down, and then out. As you can see in the chart below – WTI is red.

WTI (red) v US 10s (black), JNK ETF (purple), and S&P 500 futures (blue)

Big trouble in EM once more?

Now lower oil will release some pressure on EM.

But the release this week of the -0.3% print for South Korea’s Q1 GDP and the decision by the Turkish central bank to lean in a less hawkish direction were just two data points in a world which is again pointing to difficulties for EM economies and forex.

South Korea is broadly seen as a bellwether for overall global growth and trade which then kicks into the EM world more broadly while Turkey’s decision, not to mention the Riksbank, RBNZ, and more entreaty’s of dovishness from the ECB all highlight the difficult state the global and EM economies are in right now.

That in and of itself puts downward pressure on EM currencies and markets. But so two does this US dollar breakout we are seeing right now.  Naturally a stronger dollar knocks EM currencies, but as you can see in the chart below of the USD Index (inverted) and an ishares EM stocks and HY bond ETF.

USD Index (DXY inverted, black) v iShares Core MSCI Emerging Markets ETF (green) and iShares Emerging Markets High Yield Bond ETF (purple)

These analogs are never perfect but if the data fades across the globe once more – EM Citibank Surprise Index fell from +5.6 last week to -4.8 this week – then the expectations of EM outperformance will be under intense pressure from the USD’s strength.

And seasonality might be at play here too as we enter May according to Goldman Sachs as this tweet and chart highlights.

Source: Twitter

So watch this space folks – things could get funky.

And just quickly,  the CFTC data

USD longs are growing again as at Tuesday and are likely even higher now after the late week move. Bond bears are growing too in defiance of the markets bid tone at the moment – that is a little incongruous actually when you think about it

market is getting short volatility again as the growing VIX short shows. Danger Wil Robinson. And the clean out of the bulls may be coming for oil markets if the dip falls as far as I think it might.

The week ahead

It is going to be a huge week with the US FOMC meeting and the raft of PMI’s the highlights. recall the positive tone on the outlook for global growth of the early part of April was all about “less bad” PMI’s. But then the data deteriorated again.

So it is a big week.

We can ease into Monday though with Japan out (’til May 7) and no data EU money data and consumer, business and industrial confidence. US personal income and consumption expenditure is a big set of releases though. Dallas Fed manufacturing is also out.

Tuesday kicks off the PMI’s with the release of China’s NBS manufacturing and services PMI’s. New Zealand has ANZ economic activity and confidence while Australia release private sector credit. In Europe we get the Gfk consumer confidence data along with import prices as well as the unemployment rate. German, Italian, French and Spanish CPI is out too.

EU Q1 GDP is also out Tuesday with the market expecting 1.1% yoy growth :S. Canadian GDP is out along with ECI in the US, Chicago PMI, and the Case Shiller and pending home sales data. API crude data is out late in New York as well.

Wednesday sees a raft of holidays with Much of Europe and China out for May 1 labour day. Australia releases the manufacturing PMI, the Kiwis have employment out and in the UK its house prices, manufacturing PMI, and money aggregates. In the US its ADP employment change as we get ready for Friday’s non-farms. IHS Markit and ISM manufacturing PMIs are out as is the Fed decision, statement and Press conference after the FOMC meeting. EIA Crude stocks are also out.

Thursday kicks off with a speech from BoC governor Poloz at 6.15 am my time. then we get building permits in NZ and new home sales in Australia. The Caixin manufacturing PMI is out in China and then we see a raft of manufacturing PMI’s across Europe.  The BoE is out with its latest decision Wednesday as well while in the US we get jobless claims, Challenger jobs data, non-farm productivity and unit labour costs. ISM New York is also out.

Friday sees the release of non-farms in the US but before that we get services and then composite PMI’s across the globe, building permits in Australia, and EU CPI and PPI.  Goods trade is also out in the US.

Enjoy.

Greg McKenna
@gregorymckenna on Twitter
In collaboration with SMART Markets

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Greg MckennaUS dollar break out, US economic strength, the Fed, Oil, and EM – McKenna Macro Markets Weekly