SPY S&P500 ETF, HYG Junk Bond ETF, Yields, Dollar and USDJPY Talking Points
- The Trade Perspective: EURJPY Bearish Below 134; EURUSD Bullish Above 1.0800; GBPCAD Bullish Above 1.6500
- Risk assets swooned to start the trading week with a heavier hit for higher risk assets (Nasdaq 100 to Dow) and rate sensitive markets (emerging market and junk bonds)
- Top theme ahead is inflation – as it pertains to rate forecasts – as the US CPI feeds Fed forecasts while the RBNZ, BOC and ECB are close at hand
Risk Aversion to Start a Week Focused on Inflation and Policy Tightening
It is coming time for the markets to pay the toll on speculative indulgence. I won’t say that the markets are on the cusp of a U-turn in systemic trend, but the persistent lift that we have become so used to – almost dependent on – is meeting fundamental pressures that cannot be so readily brushed aside. This (holiday-shortened) week is focused on inflation pressures and monetary policy actions – and expectations. After years of central bank support that was further topped off by pandemic stimulus, the price pressures that are have been exacerbated by the Russian invasion of Ukraine (and subsequent sanctions) are forcing the world’s monetary policy groups to act in order to provide stability. Rate expectations are ballooning and that continues to exert a detrimental influence on traditional ‘risk assets’. Consider the S&P 500 which opened the trading week with a gap to the downside and would ultimately register a -1.7 percent drop on the day – the worst performance since March 7th. The slip below the 2022 range midpoint is meaningful, but I am still focused on conviction rather than tenuous technical sparks.
Chart of SPY S&P 500 ETF with 50-Day SMA and Volume (Daily)
Chart Created on Tradingview Platform
My preferred measure of ‘risk’ is not a single index or asset type – no matter how liquid or volatile. Rather, I prefer to evaluate the correlation and intensity of move of assets across a spectrum. When these sensitive benchmarks are highly correlated and moving with a notable momentum, it carries more weight in my evaluation of the market that something more systemic is at play. As it stands, we did see a pullback in risk through Monday, but there was a noticeably more intense move from the Nasdaq 100 relative to the Dow. That is a comparison of the same asset class (US equities) with a highlight of more speculatively appetite of ‘growth to value’. Further, there was a noticeably steeper hit to the EEM Emerging Market ETF and HYG Junk Bond ETF Monday which suggests the focus is on the pressure exacted by monetary policy expectations. That makes sense considering key inflation stats and aggressive central bank rate decisions are expected to be on tap.
Chart of HYG Junk Bond ETF Overlaid with EEM ETF and Nasdaq-Dow Ratio (Daily)
Chart Created on Tradingview Platform
What’s on Tap for Tuesday: Fed Rate Speculation
If you are following the principal fundamental currents to assess market trends moving forward, there are a few systemic matters that should be on your radar. The Russian invasion of Ukraine continues to inflict a terrible human toll, and it is draws out ever-greater sanctions from the West. I remain concerned over what kind of unaccounted exposure the world has to this cut-off country considering how significant a player it was before its being ostracized – and I will be watching the bank earnings for any indication. Aside from the open-ended geopolitical threat, there is a very explicit fundamental focus on the coming session’s docket in the form of US interest rate expectations. While there are a few important US sentiment surveys and key Fed speak, the top listing is without doubt the US consumer price index (CPI). This report is the market’s favorite inflation indicator, and after Monday’s NY Fed consumer inflation forecast hit record highs (6.6 percent over 1 year and 7.7 percent over 3 years), the table has been set for exceptional outcomes. Could this be a series easier to generate traction on a surprise shortfall – an easing and relief?
Calendar of Major Economic Events
Chart Created by John Kicklighter
To look more closely at how market anticipation is staged, there are a few measures from which we can drawn sentiment. I have been following US Treasury yields for a while, and the Fed-aligned 2-year rate has bombed higher for months. The focus more recently though is on the 10-year tenor as we price out approximately 216 bps of additional tightening from the Fed and onto the intentions with the bloated FOMC balance sheet. The Quantitative Tightening (QT) talk is still an open-ended point for market participants, but even the most dovish policy members have made an effort to draw attention to the potential. Rolling off the central banks holdings has a greater impact on longer-dated Treasuries and rebalances the Treasury curve. It also puts serious pressure on risk trends. That said, it is not wise to take our attention off the immediate rate hike anticipation with Fed Fund futures pricing in an 83 percent chance of a 50bp hike on May 4th and 89 percent probability of yet another 50bp at the June 15th meeting. That’s aggressive.
Chart of US 10-Year Yield Overlaid with Consumer Inflation Forecasts and Fed Fund Rate Forecast (Daily)
Chart Created on Tradingview Platform
Watching the Dollar Through Tuesday and Beyond
There is a lot of open-ended thematic risk and targeted event risk that is not Dollar aligned due through the rest of this week. That said, I still believe the fundamental waves will wind up on the Greenback’s shores. The March US CPI release is a very explicit event risk for data watchers who have also taken stock of the extraordinary forecasts built into the Fed and peers. Headline inflation is expected to accelerate to an extraordinary 8.4 percent, which would maintain a four decade high. It would also seriously reinforce expectations of larger rate hikes in the coming months and consistency thereafter with a more rapid balance sheet winddown. This outcome seems well priced with the DXY Dollar Index pushing a multi-year high and up 8 consecutive trading days through Monday. We have only seen 4 other instances of such a persistent run from the US benchmark in the past decade.
Chart of DXY Dollar Index with 100-Day SMA and Consecutive Candle Count (Daily)
Chart Created on Tradingview Platform
The Dollar has earned its lift through the principal fundamental drivers, but that doesn’t mean that it can continue on this path indefinitely. I believe the market is stretched with a reversal only being necessitated with some serious shift in sentiment that cuts into the premium that has been built up. While the inflation data could cool the expectations and thereby hit the Dollar, I am looking at USD-based pairs that have other fundamental pressures that can compound the potential. USDPY is once such pair. While the Japanese officials have not confirmed an official policy of intervention on behalf of the Yen – they have before and drawn the ire of the G7 – there has been a fairly overt concern projected that the local currency is falling too rapidly. While that can make exports more appealing, it also amplifies the cost of imports of commodities which the country is dependent upon. The question is: where would authorities step in? If they are not already entering the market now, I believe they will soon be making an effort given the biggest 6-week rally from USDJPY since December 2016.
| Change in | Longs | Shorts | OI |
| Daily | 10% | 4% | 5% |
| Weekly | -13% | 7% | 0% |
Chart of EURJPY with 100-Day SMA Overlaid with GER-JPN 2-Year Spread and Correlations (Daily)
Chart Created on Tradingview Platform
