It’s been a long, slow decline for VIX.  It’s been locked in a falling channel ever since the Jan-Feb correction.  As we noted last week, a breakout could be troublesome for equities.SPX closed about 12 points above important support on Friday, but futures are currently off about 12 points.  In other words, today is a critical test for bulls.

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Well, that was fun.  Just when I was wondering if investors had abdicated all decision making to bullish algos, they woke up and decided that things are a little more complicated than market conditions have been indicating.

Powell says the economy is so great that rates can continue to rise.  This is clearly a double-edged sword, as the 10Y has aptly demonstrated.  Members will remember the flattening of the yield curve poses little threat to stocks.  It’s the rapid steepening that does the damage.It’s pretty obvious, therefore, that Powell is blowing smoke and that interest rates have topped out. Why? Whether of not he employs any chartists at the Fed, I think he’s fully capable of doing the math.

Those who took an economics class or two (or even elementary algebra) can see that a continuing increase in interest rates poses serious problems for this “wonderful” economy of ours.  The tiny increase we’ve seen to date (the black line below) has contributed to a massive increase in interest expense.

Something has to give. And, by “something” I mean interest rates.SPX reached our initial target with ease yesterday, bounced for an hour or so, then tumbled to within 12 points of our next downside target before the obligatory last-minute recovery.This is where things get interesting.  Because, while a tag of the SMA50 and backtest of the January highs would make perfect chart sense, it would mean VIX breaking out of the falling channel it’s been in for months.

While I was wondering whether TPTB would allow such a thing, the employment figures came out and we got one of those trademark VIX plunges we’ve all come to expect.  The message of such a shot across the bow is clear: it can go lower, a lot lower.  Be bullish! Was yesterday’s plunge in equities close enough, in which case the more aggressive channel is in play?  Or, should we expect more fireworks today?  Not to worry. Once VIX breaks out, things will get much uglier.

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10Y rates broke out above a 30-year channel top yesterday, finally settling the argument as to the Fed’s priorities.We selected 28.56 as the upside target 9 months ago as it represented a significant enough Fib level and the top of the falling white channel.  From Jan 10’s China – It’s Not Me, It’s You:

Our view was seemingly confirmed on Feb 2 when TNX reached 28.56 and ZN reached the bottom of a long-term price channel.  It was strange, though, that the 10Y spurted up to 28.56 on the same day that SPX’s acceleration channel from Nov 9 broke down and SPX fell 59 points.

The following day, SPX fell 114 points.  And, it didn’t stop falling until Feb 9, 340 points off the January highs.  Bond prices, which normally move inversely to stocks, fell right along with SPX — and kept falling even after SPX bottomed out.  The chart below shows SPX vs ZN: 10Y prices.

Looking at it another way, we can see how 10Y yields continued marching higher as stocks plummeted, topping 28.56.  The rising red trend line from July 2016 wasn’t steep enough.  A new, steeper TL (below, in purple) took over in Sep 2017 and kept guiding yields higher until May 17.  

Fine-tuning the falling white channel, I was able to connect this peak with the previous highs from 2000 and 2007.  Like many, I noted that these previous TNX peaks had aligned with SPX peaks.  In other words, if yields fell hard as they had those previous times, stocks were quite vulnerable.

The charts suggested a drop in yields; and, so did common sense.  With $22 trillion in debt and a budget deficit topping $1 trillion, rising interest rates were unthinkable.  Or, so I thought.

I had assumed the FOMC would be able to read the writing on the wall and would take action to prevent rates from breaking out.

I don’t really think they want a breakout.  But, inflation being what it is, they’ve painted themselves into a corner.  USDJPY reached our next upside target last night, so the yen probably won’t be much help.And, oil and gas are very long overdue for a tumble — that inflation problem, again, not to mention a slew of chart patterns that spell a reversal. Note that CL has reached our 76.50 target from January.

So, here we are, this morning, with ES off 12 points, but having narrowly avoided (again) tagging its SMA20.  Usually, when this happens day after day, it’s because there’s a rising channel bottom or moving average which would make for a bullish backtest.  

This time, it smells of a failure – meaning the 10Y’s breakout is a head fake.

With VIX poised for a breakout…

…stocks might be in real trouble here.

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Another day, another after-hours meltup.  Put it all on black and give it another spin, right?  At least, that’s the message VIX is sending.

But, there are a few important caveats that suggest the message might well be a head fake.

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VIX has dipped back below the yellow channel bottom.  As long as it continues slipping lower, SPX and ES’ upside targets are presumably intact — unless oil and gas spoil the party. The hitch remains CL and RB, which not only reached overhead resistance by our measure, but must deal with inflation that’s too high, bearish API data, another round of Trump tweeting, and a large build in EIA inventory.  I think the time has finally come to revert to short, but with relatively tight stops in case this is another head fake. Then, there’s USDJPY which, as we’ve discussed, has reached channel backtest resistance.

Together with EURUSD and a resilient TNX, the pair is keeping the DXY on the rise. If it falters here at what is also very obvious horizontal resistance, stocks will come under considerable pressure. Bottom line, keep a very close on eye on VIX, USDJPY and CL. If, as I suspect, CL and USDJPY have topped out and VIX breaks out, SPX’s breakout will fail and we can look forward to sub-2500 prices.

GLTA.

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The market is quite healthy, or so goes the narrative.  Yet, day after day, we see signs of it “breaking” in the after-hours – only to be “fixed” in a V-shaped recovery the next day.

The usual “fixers,” oil, VIX and USDJPY, have limitations.  Oil can only rally so much before generating worrisome inflation headlines.  The yen can only sink so low before it starts to hurt Japanese consumers and corporations.  VIX can usually be counted on to decline when necessary.  But, there are lines in the sand that have a history of mattering.

With USDJPY and CL approaching important overhead resistance, is it now up to VIX?  Can it manage to inspire new highs or is that too much to hope for?

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Following news of a partial resolution to the US-Canada trade breakdown, futures are up about 16 points.  Aluminum and steel remain unresolved.  And, of course, there’s the issue of trade wars with the rest of the world.  But, for now, the algos are happy.

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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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