pebblewriter

Tag: fed

  • Update on Gold: Apr 8, 2020

    In our last formal update on gold in January [see: Jan 2 Update on Gold] with GC trading at 1529, I noted that although DXY had held up well, gold should benefit from loose Fed policy – but could see a backtest of its SMA200 based on the oil/gas meltdown we expected.

    I am partial, though, to the Fed putting the damper on inflation in January (reported in Feb) and setting up a backtest of the SMA200 or even the neckline which would set up another leg up to 1710-1735 in Oct 2021 or Jan 2022. Note that this would tie in nicely with the idea of an oil/gas meltdown in 2023.

    We certainly got all those things, but the timing was just a tad off.

    Long time members will remember I’ve been writing about gold’s potential Inverted Head & Shoulders Pattern for years. This post from September 2017 comes to mind.

    As I stated in that last update, I think TPTB will do whatever it takes to keep that giant IH&S targeting 1721 from playing out. The only thing I can see outweighing their efforts would be a true black swan event such as open warfare on the Korean Peninsula.

    Sure enough, every time GC got close to that neckline (the dashed yellow line above), it was smacked down by as much as 18%. It has happened 9 times since July 2016.  It was nice for trading purposes, but frustrating to the many gold bugs out there.

    While rising oil and gas prices were helpful to Aramco’s share offering in 2019, they disrupted the delicate balance between inflation and interest rates and sent a clear signal that it was finally time for GC to break out — which it finally did last June.

    Since then, it’s been a matter of waiting for the rising price channel to reach our upside targets. It might have been a long wait if not for the coronavirus. We managed to avoid war with North Korea, but this smaller, deadlier enemy was plenty Black Swan enough for the Fed.

    A few trillion in QE later, GC has reached our 1735 target — well ahead of schedule and after a very dramatic SMA200 backtest.

    Is the run over, or is there more to come?

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  • What’s Next?

    The futures are lock limit down again this morning, with ETFs trading in the after-hours indicating losses on the (eventual) open of up to 10%. This is probably not what the Fed had in mind when they unleashed the massive, emergency rate cut and $700 billion in new QE an hour before the futures opened on Sunday.

    As before, the factors are all aligned bearishly, with the bond market failing to swing back to a bullish alignment yet despite the Fed’s desperation move. There are, however, some glimmers of hope.

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  • Just Two Charts

    Two charts best define the day we had yesterday.

    First, VIX tagged our next highest target: the intersection of the .786 Fibonacci retracement and the trend line connecting two previous highs.

    The other one was the SPX arithmetic (as opposed to log) chart, which stopped on a dime at the channel bottom.The bleeding continued well past the Fed’s ineffectual $1.5 trillion injection and had to wait until the low-volume aftermarket to be staunched. At that point, central bankers went to work – pumping oil and gas, the dollar, interest rates and currencies in order to restore confidence whip up the algos. It worked…at least so far.

    I’ll have a separate post up later regarding COVID-19, including my latest projections for the US.

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  • Burning Down the House

    Once upon a time, a few boys whose families owned the biggest lemon groves in town got together and opened up a lemonade stand. It was a very hot summer, so they sold an enormous amount of ice-cold lemonade. Since they controlled the supply of lemons, they were able to quickly raise prices from 10 cents per glass to as much as $1.50. Their customers didn’t mind as they could afford 1.50, it was excellent lemonade, and there were no alternatives. They like it so much, in fact, they invested $2 trillion in shares of the stand.

    One day a freak storm hit town, and the temperature dropped from 95 to 25 degrees in a matter of hours. The weatherman said it could last for months. Not many people were interested in ice-cold lemonade, even though the boys frantically dropped their prices. They even tried cutting back on the amount of lemonade they made. For some reason, this had no effect on sales, and prices continued to drop. A few boys split away from the group and tried selling cheaper lemonade on their own, but this further depressed prices. Soon, the lemonade stand went out of business. The end.

    And that, boys and girls, is how OPEC came to be in their current predicament.

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  • Decision Time, Again

    We start this morning’s post with a peek at the Russell 2000 as it perfectly illustrates the dilemma facing the broader markets this morning.

    Up until September 2017, RUT followed a well-defined rising channel shown below in yellow.  Like all channels, it was defined by the tops and bottoms along the way. The only problem: The channel was rising only about 5% per year – hardly enough to get excited about. By late 2016, it had become obvious that algos had more influence than discretionary, fundamentally-oriented investors. The algos were, in turn, influenced by certain factors which central banks and their proxies could usually control quite easily.  By wagging the tail (the factors) the whole dog (the market) would usually fall in line.

    In September 2017, after RUT had been bumping up against the top of the rising yellow channel for over 9 months, the factors went to work and RUT  broke out of the yellow channel and rose 21% over the next year. The slope of the new rising white channel was good for about 20% per year.

    Everything was going well until September 2018 when RUT topped out at 1742 and plunged 27% in only three months. To make matters worse, the new rising white channel broke down and RUT fell back below the top of the yellow channel from which it had broken out.

    It spent the better part of the next year trying to break out of the yellow channel again – failing seven times until Dec 4, 2019, when it finally shot above the channel top and remained there. There was a scare last month when, on Jan 31, it successfully backtested the channel top and bounced 5.5%.

    Given yesterday’s carnage, though, it has fallen back to the top of the yellow channel where it faces that same important test all over again.  If it holds, all is well and investors can go back to mindless trend following.

    Even if it doesn’t, the SMA200 is now up to 1574, a modest 3.3% below yesterday’s close. But dropping through 1616ish would mean breaking down below the horizontal support (which served as overhead resistance between Oct 2018 and Dec 2019.) It could accelerate losses and complicate the rescue mission.RUT is typical of many of the indices and individual equities I chart every day. The Dow, for instance, faces a similar test at 27,700.And, SPX and ES completed important backtests (the purple channel top below) in the process of tagging our next downside targets yesterday.Given the way the factors are behaving this morning, there is a good possibility that we’ll see additional backtest targets such as DJIA 27,700 tested today. But, that would mean taking a chance on the algos’ ability to rescue stocks from some very risky waters.

    Stay tuned.

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  • FOMC Day: Jan 29, 2020

    Futures are higher this morning on what is expected to be a non-event FOMC announcement and press conference. I suspect attention will again return to currencies, as the US dollar’s surge over the past month, combined with the big drop we had anticipated in oil and gas, will serve to tamp down inflation fears.  Of course, there’s a fine line between falling inflation fears and growing deflation fears.The bond market continues to reinforce the bearish case for stocks.

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  • Who’s Propping up the Stock Market?

    It was October 1989 and the stock market was in trouble. Two years after crashing 36% (including 20% in a single session) the S&P 500 had made a comeback and had climbed back to new all-time highs. But high inflation, slipping junk bond prices and failing S&Ls were in the headlines daily. On October 13, stocks slid nearly 7% – back below the 1987 highs. It was time for action.

    Two weeks later, recently-retired Fed Governor Robert Heller penned an op-ed in the Wall Street Journal that advocated a more active approach than simply tinkering with money supply and interest rates.

    The Fed, which “already play[ed] an important indirect role in the stock market”…”could buy the broad market composites in the futures market. The increased demand would normalize trading and stabilize prices. Stabilizing the derivative markets would tend to stabilize the primary market.”

    The Fed apparently didn’t take his advice, as it continued to whipsaw for another 15 months before finally breaking above the 1987 highs to stay, relying on an barrage of rate cuts, crashing oil prices, aggressively bullish Fedspeak, and a cut in capital gains taxes.Thirty years on, there is much circumstantial evidence that the Fed has bought into Heller’s suggestions. JPMorgan estimates that “fundamental discretionary traders” account for only about 10 percent of trading volume in stocks. This means that 90% of trading either keys off of quantitative techniques or is passive (i.e. follows the quants’ lead.)

    The upshot? Triggering a few big quant managers to buy stocks can cause an avalanche of buying by index funds, ETFs, smart beta funds, etc. Picture a $50 billion tail wagging a $30 trillion dog.

    If it seems complicated, I assure you it’s not. It often occurs overnight, when low-volume equity markets readily respond to, say, sharp declines in VIX futures or a spike in the USDJPY — tried and true signals that rarely fail to ignite rallies. We had a prime example today in the wake of Iran’s attack on US air bases in Iraq [see: We’ve Seen This Movie Before.]

    VIX, which closed flat yesterday, rose sharply after the close until 7:41PM ET, at which point S&P 500 futures reached an important level of technical support. From there, VIX began an orderly decline, spurring ES to new all-time highs when it dropped below its recent lows.We’ll never know whether the Fed itself is triggering algorithms to buy until it accedes to being audited. Unlike the Bank of Japan or the Swiss National Bank, the Fed doesn’t share its trading activity. The instigator could very well be another central bank, a proxie, or just a large quantitative player caught too far out over their skis when markets got dicey.

    I’m not sure it matters all that much. The fact is that it’s happening, and happening more and more frequently — which smacks of a very directionally-biased player with access to plenty of cheap capital [of course, central banks sporting negative interest rates actually get paid to prop up stocks.]

    Heller recognized the risks in such an approach, arguing that “the Fed’s stock market role ought not to be very ambitious. It should seek only to maintain the functioning of markets — not to prop up the Dow Jones or New York Stock Exchange averages at a particular level.”

    Perhaps he didn’t appreciate, however, just how addictive support can become to both markets and politicians who rely on them for reelection. Consider how often stocks have rallied to new all-time highs on the breathless announcement of a breakthrough in the China trade wars.

    As Dallas Fed President Richard Fisher said about QE in 2016, “the Fed front-loaded an enormous market rally in order to create a wealth effect… We injected cocaine and heroin into the system…and now we are maintaining it with Ritalin.” Central bankers would do well to remember that although addictions are tough to kick, they can be fatal if left untreated.

    No one knows how much bigger the latest equity balloon can be blown. But, when markets lose their ability to fairly reflect the risk inherent in speculative investments, it’s time to start paying very close attention.

    Here, in all its glory, is Heller’s op-ed from 1989.  The highlights are mine.

     *  *  *

    Have Fed Support Stock Market, Too
    By Robert Heller
    27 October 1989
    The Wall Street Journal
    (Copyright (c) 1989, Dow Jones & Co., Inc.)

    The stock market correction of Oct. 13, 1989, was a grim reminder of the Oct. 19, 1987 market collapse. Since, like earthquakes, stock market disturbances will always be with us, it is prudent to take all possible precautions against another such market collapse.

    In general, markets function well and adjust smoothly to changing economic and financial circumstances. But there are times when they seize up, and panicky sellers cannot find buyers. That’s just what happened in the October 1987 crash. As the market tumbled, disorderly market conditions prevailed: The margins between buying bids and selling bids widened; trading in many stocks was suspended; orders took unduly long to be executed; and many specialists stopped trading altogether.

    These failures in turn contributed to the fall in the market averages: Uncertainty extracted an extra risk premium and margin-calls triggered additional selling pressures.

    The situation was like that of a skier who is thrown slightly off balance by an unexpected bump on the slope. His skis spread farther and farther apart — just as buy-sell spreads widen during a financial panic — and soon he is out of control. Unable to stop his accelerating descent, he crashes.

    After the 1987 crash, and as a result of the recommendations of many studies, “circuit breakers” were devised to allow market participants to regroup and restore orderly market conditions. It’s doubtful, though, whether circuit breakers do any real good. In the additional time they provide even more order imbalances might pile up, as would-be sellers finally get their broker on the phone.

    Instead, an appropriate institution should be charged with the job of preventing chaos in the market: the Federal Reserve. The availability of timely assistance — of a backstop — can help markets retain their resilience. The Fed already buys and sells foreign exchange to prevent disorderly conditions in foreign-exchange markets. The Fed has assumed a similar responsibility in the market for government securities. The stock market is the only major market without a market-maker of unchallenged liquidity or a buyer of last resort.

    This does not mean that the Federal Reserve does not already play an important indirect role in the stock market. In 1987, it pumped billions into the markets through open market operations and the discount window. It lent money to banks and encouraged them to make funds available to brokerage houses. They, in turn, lent money to their customers — who were supposed to recognize the opportunity to make a profit in the turmoil and buy shares.

    The Fed also has the power to set margin requirements. But wouldn’t it be more efficient and effective to supply such support to the stock market directly? Instead of flooding the entire economy with liquidity, and thereby increasing the danger of inflation, the Fed could support the stock market directly by buying market averages in the futures market, thus stabilizing the market as a whole.

    The stock market is certainly not too big for the Fed to handle. The foreign-exchange and government securities markets are vastly larger. Daily trading volume in the New York foreign exchange market is $130 billion. The daily volume for Treasury Securities is about $110 billion.

    The combined value of daily equity trading on the New York Exchange, the American Stock Exchange and the NASDAQ over-the-counter market ranges between $7 billion and $10 billion. The $13 billion the Fed injected into the money markets after the 1987 crash is more than enough to buy all the stocks traded on a typical day. More carefully targeted intervention might actually reduce the need for government action. And taking more direct action has the advantage of avoiding sharp increases in the money supply, such as happened in October 1987.

    The Fed’s stock market role ought not to be very ambitious. It should seek only to maintain the functioning of markets — not to prop up the Dow Jones or New York Stock Exchange averages at a particular level. The Fed should guard against systemic risk, but not against the risks inherent in individual stocks. It would be inappropriate for the government or the central bank to buy or sell IBM or General Motors shares. Instead, the Fed could buy the broad market composites in the futures market. The increased demand would normalize trading and stabilize prices. Stabilizing the derivative markets would tend to stabilize the primary market. The Fed would eliminate the cause of the potential panic rather than attempting to treat the symptom — the liquidity of the banks.

    Disorderly market conditions could be observed quite frequently in foreign exchange markets in the 1960s and 1970s. But since the member countries of the International Monetary Fund agreed to the “Guidelines to Floating” in 1974, such difficulties have been avoided. I cannot recall any disorder in currency markets since the 1974 guidelines were adopted. Thus, the mere existence of a market-stabilizing agency helps to avoid panic in emergencies.

    The old saying advises: “If it ain’t broke, don’t fix it.” But this could be a case where we all might go broke if it isn’t fixed.

  • Inflation Games

    Inflation drives interest rates. Though the Fed probably wishes it didn’t, it’s an inconvenient truth.  There are much tighter correlations, but consider the strong positive correlation between CPI and 10Y notes.

    This matters, of course, because with $22 trillion in debt, the US faces the same problem as the ECB and Japan: High interest rates on rising debt levels (the blue bars below) would lead to insolvency.  The slight increase in average interest rates (the black line) between 2018 and 2019, for instance, sent interest expense (the red line) soaring.

    There are only two ways to keep interest expense from consuming untenable slices of the budget: cut back on spending or bring interest rates back down and keep them down. Since the government isn’t likely to cut spending any time soon, this means focusing on interest rates.

    Japan and the ECB have coped with runaway debt by manipulating rates below zero — negative interest rates where you pay the government money to borrow from you. Though not there yet, the US is on the same path, seen most notably lately in the repo market through Not-QE.

    The government plays lots of games with inflation.  There are many different definitions, some of which include or exclude different expenses such as food, gas prices and rent. Although just as flawed as any, I like good old-fashioned CPI as it includes food and gas prices — things that affect the budget of almost every American and is factored into many important calculations such as cost of living increases.

    CPI can be influenced in some very predictable ways, some of which are subject to manipulation such as oil and gas prices.  Without harping on geopolitical considerations [see: Coincidences and Consequences] all over again, it’s obvious that the Fed’s effort to keep interest rates low is dependent on keeping inflation under control which, in turn, is dependent on keeping the annual change in gas prices under control.  How so?

    CPI (which, remember, is a measure of the rate of change in prices) has averaged +1.74% through October 2019, while YoY changes in the price of gas have averaged -6.79%. Months such as January and February, when CPI registered 1.55% and 1.52%, corresponded with the largest YoY drops in gas prices: -13.05% and -10.65%.  In April, the only positive YoY change in gas prices (+1.58%) produced the highest CPI measure of the year: 2.0%.

    The chart below illustrates the relationship so far in 2019 which simple regression analysis reveals is:

    CPI = (0.0263 x YoY change in gas prices) + 0.01918.

    In November, the rate of change in gas prices was only -3.16%. All else being equal, this suggests CPI will come in around 1.84% – a modest uptick. However, the first reading in December (unless gas prices fall) would indicate a 9.8% YoY increase in gas prices and a CPI reading of +2.18% or greater.

    That, folks, is why the Fed is considering formal changes to the way it evaluates inflation as (not) detailed in the official gobbledygook offered last month. It also explains the various comments made by Fed officials – first suggesting that inflation should target a range rather than a specific level (i.e. 2.0%) and more recently suggesting that inflation should be allowed to “run hot.”

    As the Financial Times reported:

    The Federal Reserve is considering introducing a rule that would let inflation run above its 2 per cent target, a potentially significant shift in its interest rate policy.

    The Fed’s year-long review of its monetary policy tools is due to conclude next year and, according to interviews with current and former policymakers, the central bank is considering a promise that when it misses its inflation target, it will then temporarily raise that target, to make up for lost inflation…

    If the Fed adopts this so-called “make-up strategy”, it would mark the biggest shift in how it carries out its interest rate policy since it began to target 2 per cent inflation in 2012.

    Most economists would probably suggest that the Fed has been working hard over the years to get inflation up to 2%. I strongly disagree and believe the Fed has used the constant shortfalls as the primary rationale for accommodative monetary policy – the purpose of which is to keep interest rates low and support equity prices.

    This latest prevarication is intended to provide cover for the fact that oil and gas prices have been propped up in the lead up to the Aramco IPO.  Now that the IPO is in the rear view, we’ll find out whether central banks can really stomach 2.2% CPI or gas prices are about to tumble a good 6-8%.

    If the past is any indication, the Fed won’t take a chance on CPI over 2.0% and we’ll see oil and gas prices drop substantially over the next couple of weeks. The White House wouldn’t complain, especially if it helps keep interest rates low.

    If I’m wrong, and inflation heads back above 2% (remember, the next tariff is scheduled to arrive on Monday) then we face bigger problems in January (when December CPI is reported.) I’ll post oil and gas price targets below the break.

    Meanwhile, it’s Tuesday and futures were off substantially overnight, so of course there’s news on the trade front – particularly in light of the impeachment goings on.  S&P futures have spiked 25 points off their overnight lows, but have yet to break out of the falling white channel that leads to a 3.5% correction.

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  • Because Appearances Matter

    It’s not too surprising that there’s been a firm floor under oil and gas prices, given the upcoming Aramco IPO.  But, isn’t it funny how CL has popped above its SMA200 every single day this week, even in the wake of dismal inventory data?

    Just like it’s funny that ES, which pretty obviously should have given up all its overnight trade data related gains should have given up at least most of them after the Reuters laid a little trade truthiness on us.If it had done so before the close, ES would have put in another bearish-looking daily candle.  But, it waited until later in the evening, which allowed ES to leave a bullish candle in its wake.  Funny how that happened.VIX is well-known for timely “breakdowns” that last anywhere from a few seconds to a few minutes which remind the algos of the glory which awaits them if they’ll simply buy-buy-buy.  Today, like yesterday, it hit at exactly 9:00 AM – about the time futures were trying to decide whether the market should open in the green or the red.  Watch for it to happen again if stocks should have the nerve to slip lower.But, the champion of bullish appearances has to be the USDJPY, which has reminded us of its incredible upside potential over the past month, repeatedly pushing above its SMA200 and pumping the Nikkei 12% in the process.Combined with timely soundbites from the White House on the incredible successes being achieved on the trade front, the market can’t be blamed for ramping higher most every day.  But, what happens if the narrative changes?  What happens if one or more of the factors fueling the machine runs dry?

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  • FOMC Hopium

    The approach of the FOMC meeting which begins today has been very good for stocks.  There’s nothing unusual about this. Like OPEX dates, stocks almost always rally into such important lines in the sand.

    Most investors have lost track, however, of the fact that stocks have usually declined after such meetings.With SPX a few points away from an important Fib extension, will this one be any different? continued for members… (more…)