As we noted yesterday, EURUSD is finally fulfilling our expectation of a breakdown from the trend established at the Mar 2020 lows. This move has been a long time coming and has potentially significant consequences for the DXY.
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Under ordinary circumstances, a 2.3% MoM bump in Durable Goods orders would be very welcome – especially on the heels of last month’s -1.3% print. When inflation is a growing concern due to the Fed’s largesse, however, it complicates things. For instance, might it cause the Fed to take its foot off the gas?
Not to worry, VIX was hammered sharply lower for the fourth session in a row. 
It’s now off 35% since Monday’s highs and has reached levels last seen on Feb 14, 2020, a few days before the market crashed. Note that this is the target we first charted back in early April [see: Irrational Exuberance and You]…
…when we observed that VIX was repeating a pattern seen many times over the years.
It should come as no surprise that VIX did break down and SPX did, indeed, rise above 3956. Like all the other breakdowns, this one has the potential to keep the party going long past curfew.
This time, it went a step further – breaking below a falling trend line – especially bearish for VIX and bullish for stocks. It now has the opportunity to break below the trend line from 2017 — all the reassurance algos would need in order to bid stocks even higher.
Along the same lines, RBOB futures just topped their May 2018 highs (CPI was 2.8%) and are now 27% higher than their Feb 2020 (2.33% CPI) peak – even though total miles driven in April 2021 were 10% lower than April 2020 and 11% lower than in May 2018. RBOB hasn’t been higher than this since Oct 2014 when CPI, now 5%, was retreating from its recent 2.13% highs.
If this all seems a little overdone, you’re right. The economy has rebounded. But, few responsible economists would argue that things are better than in Feb 2020 when markets crashed as the pandemic roiled the global economy.
The obvious X-factor, of course, is the massive amount of money the Fed has thrown at markets. The less obvious factor is the ease with which the Fed can manipulate algos. The warning signs which used to cause correction-causing reversions to the mean — rapidly rising inflation and interest rates, rising volatility, etc. — are no longer legitimate concerns.
Why? Because the Fed has proven that stocks can keep rising even in the face of data that would otherwise be problematic. So what if inflation is out of control? Interest rates sure don’t reflect it. Below trend GDP? All the more reason for massive QE. 
They haven’t learned how to cure the patient, let alone prevent him from getting sick. But, they’ve rigged the thermometer, the blood pressure cuff, and the stethoscope to indicate that everything is just fine.
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If yesterday’s better than expected ADP jobs data was bad news, then it stands to reason that today’s worse than expected DOL NFP print would be good for the market. 
Well, that, and the 13% pounding VIX has taken…
As it was hammered back below its SMA10, ES was ramped up above its SMA10. Funny how that works.
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You could argue that the annual PCE print of 3.6%, the hottest since 1992, is merely a function of the base effect – last year’s crash in inflation.
But that argument falls flat when you consider that MoM Core PCE, which is completely unaffected by the base effect, soared by a record 0.7%.
Naturally, both stocks and bonds ignored the data. After all, VIX has plunged 36% in the past 7 sessions, so everything must be okay, right?
Not so fast.
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The Dow, the most easily and commonly manipulated index, has gone nowhere since failing to hold its 3.618 Fib extension at 34,430. It begs the question: what’s the holdup?
Usually, when a closely followed index goes sideways for a while, it’s because an important moving average is moving into position for a backtest. But, is that the case here?
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I had an great question yesterday regarding the bond market: “Is it possible the fear of pandemic in spring 2020 affected the behavior of 2yr and 10 yr and then indirectly triggered the crash?”
Pebblewriter longhaulers will recall that our bond cycle model forecast a severe plunge in interest rates long before anyone was talking about a pandemic. In August 2019, for example, we were already anticipating a drop to near or below zero around December 2020.
It’s what the charts suggested, as we posted in April 2018 [see: Bonds – a Buying Opportunity]…
…and it’s what was necessary in order to keep America’s books balanced. Annual debt growth was averaging 5%, and debt:GDP had topped 100% for the past five years.
As we pointed out in July 2019 [see: Why Interest Rates Must Not Rise] the only way to keep debt service from overwhelming other federal expenses had been to crash interest rates.
The trick was how to force interest rates lower without alarming us economist types. Past maneuvers had involved adjusting Fed policy (not terribly effective for medium and long-term rates) and forcing inflation lower by forcing oil and gas prices lower as occurred in 2014-2016 and late 2018 (detrimental to stock prices.)
CPI, which had spent most of 2018 above 2%, had declined to a more manageable 1.7% by September 2019. But, the year-end ramp job in oil prices sent CPI up to a troubling 2.3% by December. The 10Y rose from 1.43% in September to 1.95% in December and, as the chart below shows, threatened to break out. Something, as they say, had to give.
As the big brains at the Eccles Building were spitballing potential solutions, the most extreme case of deus ex machina imaginable landed in their laps. COVID-19 did the Fed a solid – albeit one which went way overboard.
Oil prices, inflation and the 10Y were suddenly in a race to zero (oil won) and the Fed suddenly faced a slightly bigger problem: how to prevent Armageddon. They needed higher oil prices, interest rates and inflation just to talk equity investors (well, algos) off of window ledges.
It worked so spectacularly well that they painted themselves back into a corner very similar to the December 2019 one: rapidly rising inflation and interest rates thanks largely to spiking oil and gas prices – exactly what our models predicted would happen. YoY gas price increases and CPI have been so highly correlated that they are now literally on top of one another.
For the past few thousand years, this would have been a serious problem. Everybody knows interest rates spike when inflation spikes. Since the Fed essentially took over the bond market, however, they’ve been able to convince bond investors (well, algos) that spiking inflation isn’t a problem and, even if it is, it’s transitory.
Want proof? Rates have actually declined since April’s 4.2% CPI print and are nearly back to the same level as before the bomb was dropped.
If I walked up to you on a cloudless day and insisted that shaking my rain stick will make it pour, you’d probably double over with laughter. If I had a secret accomplice spray water from a garden hose all over us from an undisclosed location, you might begin to wonder if I was right.
That’s what’s happening with interest rates right now. Except the rain stick is the Fed’s prognostications and the garden hose is actually a low-flying supertanker carrying 20,000 gallons.
Of course bond investors care about spiking inflation. But, with the Fed pumping billions of dollars into the bond market every day (more on days with alarming economic data) to force interest rates lower, they can claim that said inflation (“did we mention it’s transitory?”) is obviously not a problem. And the dopes in the financial press eat it up because, by God, they’re soaking wet.
Instead of rising, interest rates decline, proving to all (especially the algos) that the Fed must know what they’re talking about or — to us more cynical types — that they’ve completely destroyed the bond market’s price discovery mechanism.
So, did fear of the pandemic affect bond behavior and, thus, cause the crash? Absolutely – though it’s a bit of a chicken and egg situation. Everything unraveled at about the same time in the mother of all negative feedback loops.
The irony is that it accomplished what the Fed needed to happen in the bond market — though to excess. The Fed can now use the pandemic as their excuse for the most rapid expansion of monetary supply in history– even as spiraling inflation crushes the disadvantaged whom the Fed claims it’s desperate to help.
Now, on to the markets. No surprise, but futures managed to ramp higher again overnight – creating the illusion, at least, that the downside case is off the table. 
It’s not.
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Interesting piece in Reuters today on Japan’s vaccination efforts and the overwhelming level of infections in Osaka, Japan’s second largest city, only two months ahead of the Olympics.
While many countries are making good progress with vaccinations, Japan – the 11th most populous country in the world – is lagging badly. It’s not the only country in Asia to be struggling.
A close-up of vaccination rates shows that many Asian countries are in the same boat.
Will the Olympics be the next global superspreader event or, perhaps, the next Tom-Hanks-has-COVID! moment?
Those who have put off getting vaccinated might want to consider the number of daily flights from Osaka to the US…
Meanwhile, futures are paying more attention to the daily pre-opening VIX plunge and a bond market which seemingly no longer cares about inflation.
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Yesterday, futures broke out of a very well-formed falling channel for the second time this week. Will it stick this time or is this just typical OPEX nonsense?
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Live by the algo, die by the algo…so the saying goes. ES continues to make good progress toward our downside targets, with the usual assistance from currencies and commodities AWOL so far.
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Blockbuster jobs data? Not so much. At 266K versus over 1MM consensus, it was the worst miss since 1998.
The futures initially held the overnight ramp, taking their cues from VIX, which barely budged on the hugely disappointing print.
But, VIX also hasn’t (yet) broken down the way it normally would if a full-court press were on to preserve the rally – the kind we saw yesterday when Atlanta Fed President Bostic served up new all-time highs on Dow by insisting that tapering mustn’t even be discussed (lest Death Eaters be summoned!?)
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