Updates

Bond rally and data flow spook traders and investors – McKenna Macro Markets Weekly

on March 24, 2019

Hi folks, welcome to my weekly newsletter. 

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Key Themes driving markets

THIS WEEK’S NEWSLETTER IS DEDICATED TO THE BOND MARKET – SHAKEN AND STIRRING OTHER MARKETS

Bond rates surge as the global economy tanks….

During the week US 10 year bonds broke the bottom of what I had termed the Goldilock’s Zone between 2.55% and 2.82%. Something I’ve had in my positioning thoughts for months now and something I’ve oft repeated in this weekly is that rates below the bottom of the range would not be a good thing.

Indeed, “if 2.55% range low were to break that would be a bad signal for risk assets” is what I’ve had pinned because the type of data flow that would be necessary to do that would signal the economy has gone awry – in the US and across the globe.

US 10 Year Treasuries Rate Weekly – TradingView

When that level broke during the week I highlighted in my daily Newsletter (as I had in this note last week) that I now had a target of 2.28%.  That is the 138.2% target of the break of 2.55%. But as you can see in the chart above the case for even lower levels looks high now that the convergence of important support has given way in the 2.49/51% region.

2.02/2.05% is in the frame folks – maybe even the record low eventually.

Now, I know you are going to say that the Fed’s dovish tilt has been the primary driver and that is true. But it is the data – and a little stocks market shenangins in thin holiday liquidity – which caused the Fed pivot.

But the data has been weak. Just look at that table above only the UK is materially beating beaten down economics expectations while Australia is slipping toward negativity once again.

EU Citibank Economic Surprise Index Weekly

More importantly Europe has been below zero for almost all of the past 13 months while on Friday it’s composite “flash” PMI fell back to 51.3 – a two month low. Likewsie services printed a 2 month low of 52.7 while the manufacturing PMI and manufacturing PMI output indexes hit 71 month lows of 47.6 and 47.7 respectively.

IHS Markit’s Chris Williamson said in a note accompanying the release that:

“Forward-looking indicators such as business optimism and backlogs of work suggest that growth could be even weaker in the second quarter. Worryingly, with order book backlogs shrinking at the steepest rate since late-2014, more and more companies are pulling back on hiring, and likely reviewing their investment spending.

Any such further loss of growth momentum in the second quarter compared to the 0.2% GDP rise signalled for the first three months of the year would raise doubts on the economy’s ability to grow by more than 1% in 2019.”

In contrast those 4 measures above for the US printed 54.3, 54.8, 51.6, and 52.5 respectively with IHS Markit’s Williamson saying in a note, “The PMI survey
data nevertheless remain encouragingly resilient, indicative of the economy growing at an annualised rate in excess of 2% in the first quarter, suggesting
some potential upside to many current growth forecasts.”

Anyone want to buy Euro folks. Yellow vest protests week after week in France, Italy abandoning the west and signing on to China’s Belt and Road, Brexit still a mess with a not insignificant chance of no-deal, and then potentially fractious EU elections in late May.

Oh, and that’s before we factor in relative economic and central bank outlooks.

1.1185 is the key – but Euro is setting up for a sharp fall in the months ahead. That’s important for Global Forex

The Euro, the USD, and by consequence a large number of forex pairs have been in ranges recently. It’s something I’ve stressed here in the weekly and in the dailies for some time. I’ve often written not to get too excited about the coverage of one days moves because we are still in the ranges.

But, while the rangey nature of this market is still holding true the setup is growing for an eventual break of the Euro down below 1.0990, toward 1.08 and perhaps 1.04/05. The DXY will be up and through 100/101 on that scenario and likely stronger in time.

But let’s focus on the weekly Euro.

EURUSD Weekly – TradingView

In the chart above we have a clear test of the 61.8% retracement level of the 2016/18 rally recently at 1.1185 from which the Euro bounced. That low, actually around 1.1175, came on the day Mario Draghi and the ECB waxed dovish. Last week’s spike high in the EURUSD, which couldn’t hold above the medium term down trend channel, happened on the day the Fed waxed dovish.

That gives us a nice bookend of the move and a very ugly weekly candle.

Now, it is important to note that the USD is still in the overall widish range. but the lower highs of the past 6 months – of which last week’s was the fourth – points to a downtrend.

So, my outlook is for  a test back toward the 1.1175/85 support and if (when) that breaks a run to 1.0990 with 1.0800/50 the bottom of the channel at the moment.

If we see this we will see a substantially stronger USD across the board – except perhaps against the Yen, though it will gain materially on the crosses. Under this scenario I’d expect the AUDUSD to be at 0.6800/25, maybe lower, USDJPY around 1.0770/1.0830, and USDCNH back toward 6.85/90 – but in many ways that’s another story.

More troubling under this scenario, is what USD strength, will do to EM forex levels, their economies, and stocks markets. Especially in the current economic environment.

Can I be wrong? Of course. If I am, sell rallies in the Euro, Aussie and so on, and wait for the inevitable break of the ranges.

The outlook above is triggered by a clear break in a level on the EURUSD – so we are still rangey till then. And this outlook is very macro rather than simply trading. So it may take time to play out. But it’s where things are now starting to set up – even as the US economy slows a little

Bonds know this but do stocks? “US PMI signals greatest pressure on corporate earnings since 2016” says IHS Markit

Earlier this week (March 20) in the daily newsletter I included the following chart and said, “…with concerns about earnings and the economy it is easy to see why big money investors are not yet rushing to join the party”. That was in reference to the BAML survey with the chief strategist noting the biggest chance was a melt-up because so many investors hadn’t joined the rally.

Source: Daily Shot via JesseFelder’s Twitter

To that end after the US flash PMI IHS Market said that, “PMI survey data provide an accurate advance guide to corporate earnings growth, EPS gauge is derived from survey indices measuring sales, pricing power and profitability, and frst quarter earnings momentum is at three-year low”.

Source: IHS Markit

The point being that bonds get this, they see the slowdown. Stocks not so much in price but certainly in the lack of real money participation in the rally so far. USD you ask…that’s about relativities not outright levels.

Stocks then?

Despite the rally Thursday in US stocks I wrote in Friday’s newsletter in the Positioning Thoughts section that (bolding for this week’s note) “not triggered on the S&P short [signal from the previous day] and fundamentally I don’t like this market where it is. It smacks of QE and maybe that’s what is coming but prices seem preemptive. But technically support is holding. I’m going to pencil in a move to 2,740/70 as a minimum. It’s a question of when”. 

S&P 500 Weekly – TradingView

Now of course, you can see the blue arrow which is my JimmyR indicator which suggests process are still biased higher on a weekly basis. So I’m not outright bearish. But my system has generated another sell signal if Friday’s low is taken out Monday and – as the chart below shows – there was a lot of bearish engulfing days trade Friday in the US.

Source: Twitter

That matters because if the US does catch cold for more than a day or a week then so too will global markets. Here’s the monthly chart of the S&P 500 versus the Nikkei, DAX, and FTSE.

Stocks Monthly – S&P 500(black), Nikkei(blue), DAX(orange), FTSE light blue)

Chances of a funk with bonds where they are, earnings looking crook, and the data printing poorly across the globe have to be rising. 2720/45 looks incredibly important for the S&P 500 and thus global markets. Below that and things get funky again. But that is support for the moment.

Theresa May – Monty Pythons Black Knight or a Machiavellian strategist Redux

Ugh, Pommie Pollies. What a hash they have made of the Brexit process.

1 million people walking in a street protest to let the people take back the process, weekend news that Cabinet is trying to plan a coup even though theoretically they can’t oust Mrs May till the end of the year.

Britain has a short window with which to work itself out thanks to an EU withdrawal extension. But the chances of a no-deal Brexit have likely risen to a non-material 20/25%.

That means it is still the risk case not the base case. But the clock is ticking.

And just quickly,  the CFTC data

I want to highlight what I wrote last week again this week;

“…check out the 10 year short coming down. Look out for a short covering rally folks if 2.55% breaks. It could move materially, 2.28% would be my target on a break. That could fuel a big rally in stocks initially. At least until folks recognise what’s caused it”.

As you can see as at last Tuesday there had been a small but not immaterial fall in the net shorts. My guess is next week’s report will show a materially lower net short. The tailwind of this unwind and potential positioning switch to longs could drive the 10 year to my targets articulated above.

US dollar longs are still substantial but history suggests there is more position limits available.

The week ahead

The last week of March could prove mercifully quiet given the lack of data flow. But with multiple speeches from Fed members, RBA assistant governor Kent, as well as the RBNZ decision and a speech from Mario Draghi keeps central bankers front and centre.

Not to mention the price action of bonds and stocks themselves.

Monday we here from the Fed’s Evans (twice I think) in the Asian session, BoJ’s Harada speaks as well and we get Ifo expectations, current assessment, and business climate.  Fed’s Harker is speaking in US time when the Chicago Fed national activity index and the Dallas Fed manufacturing index will be released.

Tuesday, the RBA’s Luci Ellis is speaking early morning Australian time. We also get Kiwi trade, the BoJ’s summary of opinions, Fed’s Rosengren will give a speech and we’ll get the release of the Gfk consumer confidence survey in GUS housing starts Germany.  US housing starts, building permits, Case Shiller, consumer confidence, and the Richmond Fed manufacturing index are all out along with the API crude data.

Wednesday the RBNZ’s interest rate decision is the highlight though rates are expected to be held at 1.75%. Like other central banks it is what they say that is the key. We also hear from the ECB’s Mario Draghi and De Guindos  who both give speeches. US and Canadian trade is out along with the API crude data. Esther George from the fed will speak at the end of the day in the US very early Thursday in Asia.

Thursday sees the release the ANZ business and activity index, EU money supply, industrial, business, and consumer sentiment. The Fed’s Quarles will be speaking while Jobless claims and the latest read on Q4 GDP will be out. PCE data will also be out at the same time be German inflation, a speech by the fed’s vice-chair Clarida, pending home sales, and Kansas Fed manufacturing index.

Friday rounds out the week with Tokyo CPI, Japanese employment, unemployment, industrial production, and retail trade are out. RBA private sector is out along with German import prices, retail trade, and unemployment. UK GDP is out along with US personal consumption, income, and expenditure data along with the Chicago PMI, new homes sales, and a speech from the Fed’s Quarles.

A big week, not as huge as the last, but plenty to chew on just the same. Enjoy.

Greg McKenna
@gregorymckenna on Twitter
In collaboration with SMART Markets

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Greg MckennaBond rally and data flow spook traders and investors – McKenna Macro Markets Weekly