By now, most members are well-versed in the important role USDJPY plays in propping up equities.  In fact, the yen carry trade is alive and well, and continues to rescue stocks on a daily basis.

In our last dedicated update in July USDJPY [see: USDJPY Reaches Critical Resistance] I noted that the pair had backtested the major channel which had guided it steadily higher since its 2011 lows and called for a backtest of the SMA200.

…the most likely course of action is a backtest of the white channel top and SMA200, ideally when they intersect a few months from now — but, sooner if SPX falters. The SMA100 and SMA200 will intersect in about a month, which is another legitimate target as that’s when SPX’s rising white channel encounters the Jan highs.

Indeed, USDJPY backtested its SMA200 five weeks later — the same day SPX tested its Jan high.   We immediately looked to the .886 at 113.59 as our upside target.  From Currency Complications:

USDJPY reached our target at the SMA100/SMA200 overnight, at least temporarily bringing the pair back below the top of the falling white channel from which it broke out on July 10…[it] is about to go on a market-ramping tear to 113.59…

This morning, it reached 113.59.  It was a good two weeks later than originally expected.  But, that was actually a positive sign for bulls.

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It was an unusually strange quarter in an unusually strange year.  Somehow, we got through it.  But, it wasn’t all that fun to trade.

The past few days were a great case in point: strong ramp job into the FOMC announcement, followed by an even sharper spike, followed by the rug being pulled out from under, followed by another sharp spike, followed by today’s plunge.  I have slid the SMA20 tag to the right three days in a row.

On the other hand, we’ve had some nice wins.  USDJPY tagged our 113.59 target overnight.  Yes, it came three weeks later than expected (Sep 6).  But, at least it happened.   Then……and, now.Of course, by delaying the tag USDJPY avoided a backtest of the large white channel.  The last time this happened the pair’s subsequent slump did a number on stocks.

And, while we’re talking about slumps…don’t look now, but VIX finally tagged our next upside target.

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It was a strange press conference.  As we discussed yesterday, stocks would react kindly…

 …if Powell is successful in convincing investors algos that the economy is strong but there is no wage pressure and inflation poses no real threat.

I think he succeeded in portraying the economy as strong.  This morning’s economic data helped bolster that narrative (as long as you don’t look too closely.)

As far as wage pressure, the official data continues to suggest it’s not a problem just yet.  As far as inflation, however, I think he came up short.

Unless Trump is successful in reversing the damage he touched off by ripping up the Iran deal and starting a tariff war, inflation is a problem.

As long as inflation is a problem, rates will continue to rise.  There are many who insist rates need to rise quite a bit more in order to stave off runaway inflation.  Ordinarily, this might not be a problem.  But, given that America faces runaway deficits and debt, it is a yuuuge problem.

Perhaps it was this realization that unraveled the ramp job as soon as Powell finished speaking.  It’s simply not possible to keep inflation in check in the midst of a major trade war and with much of the global oil supply being taken off the market.

Fortunately for the bulls, SPX found support at an important channel line.  But, it’s not the sort of channel that lasts.

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After bouncing off our initial downside target yesterday, stocks ramped nicely into the close and overnight.  But, the overnight ramp job is fading fast, and it remains to be seen whether the backtest scheduled for the opening bell will hold.

The focus over the next couple of days is, of course, the Fed.  There is strong consensus for a rate hike tomorrow.  In addition, the market faces the headwinds of the tariff war(s), growing turmoil in D.C., and the usual instability in the Middle East, etc.

Will investors press the pause button?  It all depends on the comments offered by Powell et al.  Some have argued that the Fed was hopelessly behind the curve — even before Trump’s tariff war amped up inflation.

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The trade dispute is officially a trade war.  You’d never know it from looking at the stock market.  The bond market, however, is a different story.

Tariffs will clearly add to inflationary pressures.  But, even before the “trade wars are good, and easy to win” gaffe, the Fed and a bevy of inflationary economic reports had been working the short end higher.

As we’ve maintained [see: Inflation…Goalseeking] stock valuations aren’t adverse to rising inflation.  It was only those rises above the Fed’s official 2% target which produced downturns between 2009-2017.

And, even though the 10s2s spread has generated plenty of trepidation, it was rapid spikes in the spread — not the inversions themselves — which did the most damage.

The Fed has little to fear from inversions except, as is the case with QE, the difficulty in walking them back without popping the equity bubble they’ve blown.  The general perception is that inversions usher in recessions, but surely the Eccles brain trust has a solution to that pesky problem.

No, the issue the Fed is grappling with these days is how to get the rest of us to believe that higher inflation and higher interest rates don’t really matter.  A scant 7 years ago, when the Debt Ceiling Crisis of 2011 and US downgrade were the news of the day, the S&P 500 plunged over 22%.  Total interest expense on the $14.8 trillion in government debt was $454 billion.

Interest expense this year will total about $520 billion on $22 trillion in debt.  The doubling in short-term and floating rate debt funding and the sharp decrease in rates on long bonds (averaged 5.8% in Sep 2011) has allowed interest expense to increase only 15% while the amount of debt grew 46%.

But, any way you slice it, $520 billion in interest expense is a tough pill to swallow — especially when we’re running a $1 trillion deficit.  Japan, here we come.

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Yesterday was all about fine tuning, positioning SPX/ES for a breakout — which arrived at 2am courtesy of the breakdown in VIX we were expecting.

Is the start of another prolonged period of VIX bashing?  And why now?  Has it anything to do with DXY finally breaking down?

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ES reached new highs yesterday, but SPX reversed at its .886 Fib retracement.  Which should we believe?  Since VIX is plunging in the minutes before the open, indications are that this morning’s selloff will be just enough for SPX to flesh out its latest rising channel — also on the way to new highs.

What could go wrong?  Plenty.  For one, 10Y yields are threatening to break out of a channel dating back to Jan 2000.  This seems to me to be a very dangerous game the Fed is playing.

The Fed clearly wants more headroom in rates on hand for the next economic disaster.  And, the 2Y continues pushing higher, perhaps to buoy the dollar and keep inflation from running away.

As the 2Y rises, the 10Y must at least keep pace in order to prevent a yield curve inversion.  But, yield breakouts have been unhealthy for stocks over since 2015.  With debt accumulating quickly, why would this one be any different?

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