Futures are flat at the moment, despite sizeable moves in WTI (-2.14%) and RBOB (-2.62%) and a sharp pop in rates.  While we wait for oil and gas to reach our downside targets, I thought it would be a good time to revisit our yield curve charts.

Many of you will remember this chart from May 3 [see: The Yield Curve – An Update.]

At the time, I considered it one of the most important charts to keep an eye on.  Previous bounces off the TL connecting those previous lows correlated strongly with the 2000 and 2007 crashes.

With the 10s2s spread approaching negative territory, we wondered whether or not we’d see a repeat.  Here’s where things stand now.  Note that the curve has not only reached the TL, but has dropped beneath it.

As we’ve discussed many times, a flattening curve is typically positive for stocks.  It’s those sharp spikes higher that do most of the damage.

Back in January [see: China – It’s Not Me, It’s You] I pegged the upside for TNX at 28.56.  I considered the rise above it February an overshoot, convinced that it wouldn’t last. I was partially right. As expected, the pop up to 31.15 in mid-May didn’t last.  But, TNX has clung stubbornly to our target range.  The purple TL from Sep 7 held until May 25, at whit point TNX broke down and tagged our initial downside target — but, not further.In fact, it experienced a strong backtest that lasted through mid-June, and is still hanging around 28.56.

One might wonder why, with the Fed so involved in “managing” interest rates, TNX has been so hesitant to reverse.  That’s where the yield curve comes in (and, a little currency manipulation.)

With the short end of the curve rising in conjunction with the FOMC’s rate hikes, a bigger drop in the 10Y could easily produce an inverted curve — generally considered a precursor to a recession.

10s2s is presently positive by only 25 bps.  So, there is precious little room for the 10Y to drop — at least until the Fed stops hiking rates.  Glass-half-full analysts see rate hikes as appropriate, given the economy’s strong performance.  Cynics see them as a maneuver to create more headroom for the next time the Fed has to step in and save the markets.

Whichever the case may be, the Fed will prevent an inversion for as long as possible.  If/when one does occur, they will be even more cautious about allowing it to unwind rapidly.

If things go according to plan, oil and gas will drop just enough to dissipate the recent inflation pressure — allowing DXY to settle lower along with 10s and 2s.  If they don’t, things could get ugly.

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As we discussed yesterday, USDJPY has reached a critical line in the sand.  As one of the primary drivers of equity algos [see: Yen Carry Trade] this creates a potential headwind for stocks.

Over the years, oil and the USDJPY have mostly offset each other – with one bolstering stocks while the other resets (or, moving in tandem if the situation is dire enough.)  The most significant such event was in July 2014, when WTI’s crash began on the very same day that the USDJPY broke out to new highs.

This enabled Japan, which had recently seen inflation near 4% as a result of soaring oil prices, to withstand even further yen depreciation.  It also enabled SPX to remain above the critical resistance (1823) through which it had recently pushed.

As oil crashed, Japan’s inflation rate settled back down to the level at which the BoJ could justify continuing an insane amount of QQE (which continues to this day.)  And, SPX went merrily on its way to its next technical resistance at 2138, backtesting 1823 another 4-5 times (in case there were any unconvinced bears left standing.)Why the history lesson?  The huge white channel that has carried USDJPY higher since 2010 broke down on January 24, two sessions before SPX topped out and began a 340 point (11.8%) correction.

When SPX finally bottomed out at its 200-day moving average on Feb 9, it was because USDJPY was making noises about rejoining the broken white channel and because oil took the opportunity to bottom out and begin a 29% rally (yep, the same day.)

While CL did the heavy lifting, USDJPY reset for the next six weeks.  It bottomed on Mar 23, the very same day that SPX tagged its SMA200 for the second time.  USJDPY has since supported SPX’s slow, tortuous climb back above a key Fib at 2703 ever since.

But, yesterday, it reached a critical line of resistance — a backtest of the huge white channel from which it originally broke down and instigated the Jan-Feb correction.Normally, backtests mark reversals. So, when we talk about reaching “critical resistance” we’re not just talking about the currency pair.  If USDJPY doesn’t push through resistance, stocks will not be amused.

We’ll take a look at the various scenarios and the likely outcome of each.

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We’ve been beating the inflation drum for months, wondering when the folks behind the curtain would finally pull the levers to reign in energy prices.  Yesterday was a good start, as gasoline and WTI futures were both off sharply.

Ordinarily, we’d expect to see stocks suffer in tandem.  But, as we discussed yesterday morning:

So far, [VIX] has put the brakes on at a backtest of the recently broken straw-man trend line.  If it can remain below the red TL and the SMA200, and USDJPY keeps ramping, stocks will suffer a mild pullback.

That’s exactly what happened.  Another VIX pullback this morning……coupled with a breakout by USDJPY……has futures in the green by 15 points.But, of course, CPI isn’t out just yet.

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USDJPY reached our upside target this morning, tagging the top of the falling white channel from 2015.  This is the terminus of a move which began in late March [see: Algos to Markets – All Better.] This is a pivotal point for the pair, particularly since ES reached its IH&S target overnight.continued for members… (more…)

Futures are slipping higher this morning… …primarily on follow through from VIX’s dump below support.continued for members… (more…)

Stocks did all they could, yesterday, to project renewed strength.  But, despite gaining 23 points, SPX didn’t break out of the falling channel it’s been in for a month.  Neither it nor ES were able to clear the neckline of their IH&S Patterns.  And, though DJIA finally closed above its 200-day moving average, it was by 3 points, literally in the final 10 seconds of trading.

Toss in the fact that RB, CL, USDJPY and DXY are all sliding, and VIX remains above horizontal support, and you get the feeling stocks aren’t ready to commit to higher prices.

It’s the same sense I get when I read the Fed minutes.  Things are going so great that they need to raise interest rates twice more.  But, they can’t shake the feeling that a recession is just around the corner.  So, they’ll probably stop hiking soon — coincidentally, right about the time the yield curve (as a result of their hikes) would otherwise invert.

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If you liked Tuesday, you’ll probably like today.  We have an apparent overnight ramp in RB and CL (to the same overhead resistance)……a dip in VIX (to the same support)……and, another close by DJI below its SMA200.This time, S&P futures are up 17.5 points (previously 12) and still haven’t broken out of the falling channel from Jun 13 nor above the IH&S neckline.It’s not hard to imagine the instructions arriving from the Hamptons: “just don’t let it crash!”

And, speaking of crashes…I saw a few very interesting charts this morning.  The first depicted a pace of corporate buybacks that was shocking.  According to BAML, corporate buybacks are practically the only net purchasers so far this year.  Imagine that.

The other put the rise in gas prices into perspective.  Most Americans are spending incrementally more on gas than they received in cuts from the recent tax bill. Take the lowest 20% earners and multiple the 8% of their income spent on gas in 2016 by the 30% YoY increase we’ve seen.  The 2%+ increase in expenses easily outpaces the zero-point-whatever benefit they received from the tax bill.  No wonder Trump is getting a little nervous.

Or is he?  If you’re the leader of the free world and have a direct line to the leader of every friendly OPEC member, is a tweet really the most effective way to get your message across?  Or, is it just possible the tweets are window dressing, intended for his supporters?  Just a thought.

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The overnight ramp job might feel like the real thing……if not for USDJPY’s breakdown.  If the wizards really wanted to complete the IH&S Pattern and send ES soaring to 2800, there’s no way in the world USDJPY wouldn’t have held the TL it’s been working on since Jun 25. Note the negative divergence between the pair (higher highs) and ES (lower high.)

VIX made a valiant effort.  And never say never, of course.  After all, SPX did bounce off the critically important 2.24 extension again.  And, holidays are notorious for nonsensical leaps over tall buildings. But, for the time being, this looks like a headfake.  ES 2743 and SPX 2741.50 are the (neck)lines in the sand.

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