Lots of targets being hit, lately.  We’ll start with EURUSD, which tagged the channel top we had originally scheduled for later in September.  ES nailed our .786 and channel midline target.

VIX slightly exceeded our 16.66 target.And, most importantly, WTI came within .07 of our primary downside target and has yet to bounce much.

Since it fell just short, and RB remains a few cents above its target, we’ll take a look at the road forward for CL and RB and how they should impact the bigger picture.

continued for members…

First, a quick look at the rest of the cast.

Though SPX didn’t quite reach its .886, it tagged the neckline and channel midline — close enough.  If it can make it back above its SMA10 at 2840.12, then we can ignore the additional downside targets for the time being.  Otherwise, they are still in play.The bigger picture on ES shows it is backtesting the broken red channel.  If it rejoins, the bulls are back in charge.  If not, then our downside targets are still in play.

USDJPY continues to waffle, as expected.  Since its SMA200 is turning down, there is a decision to be made regarding getting the tag over with now or waiting until it can be done as a backtest — at an obviously lower level — later in the year.

One way to “punt” would be to tag the SMA100 when it reaches the channel top and save the SMA200 for a more dramatic moment, such as a FOMC rate hike.

And, RB remains within striking distance of its SMA200……with very little effect on retail gas prices just yet.

TNX remains steady at 2.86, the target we originally set for last year.  It has now been over six months since it first reached it.  And, the comparison with RB continues to make sense.

As long as VIX can hold ES at or near (especially above) the red channel bottom, I think CL and RB will go ahead and do the formal SMA200 tags.  The question, then, is what’s next?

Oil & Gas – continuing:

Oil bottomed on Feb 11, 2016 – the same day that SPX bottomed and backtested its 1.272 at 1823.42 for the last time.CPI in January had come in at 1.37%, the first time it had topped 1% since Nov 2014.  Remember, it had spent 2015 at or below zero.

The Fed and the government was understandably concerned about deflation. Increasing oil and gas prices was an easy way to spark inflation.

Between Feb 2016 and Jan 2018, RB and CL followed rising channels (purple, below) that increased at about 8-9% per year.  Energy accounts for roughly 8% of CPI change.  So, all things equal, an 8% increase in energy prices would result in a roughly 0.64 change in reported CPI — quite meaningful when CPI is only 1-2%.

For quite a while, the oscillations relative to the purple channels were extremely reliable and aided many spot-on forecasts. But, as it turned out, an 8% annual ROC wasn’t enough.

On Jan 3, 2017, SPX reached the 2.24 Fib at 2703.62 — a place it might easily have reversed given that it also represented a channel top.  It needed help to overcome the resistance.

Also, by then, the FOMC was starting to think about building in some headroom for the next round of QE — whenever that might come.  It was time for oil and gas to break out.

Once the algos saw oil and gas break out of their purple channels, SPX easily broke above 2703.  But, gas prices dipped back below the purple channel top and the algos were not amused.  SPX gave up 2703 in a hurry.  What were the plans for CPI?  It was already above 2%.  Would the FOMC actually endorse “excess” inflation with accompanying higher interest rates?As it turned out, they did.  The slightly steeper red channel…

…quickly gave way to a much more aggressively rising white channel.

It matches CL’s rising white channel very well.

The Fed has been quite willing to see CPI increase as high as 2.95% (July), a 10Y that topped 3% (3.115% on May 17) and a 2Y that reached 2.69%.

Though the 2s10s spread has shrunk to recession-warning levels and interest expense on the national debt threatens to spiral out of control, they realize they need the headroom.  And, besides, SPX has managed quite nicely to hold 2703.

The only problem is how and when to turn it off.  If inflation returned to pre-crisis levels of 3-4%, the 10Y might easily top 4-5%, which would greatly expand the deficit.  With July at 2.95%…

The white channel’s annual ROC for both CL and RB is about 26% — implying an ongoing CPI effect of a whopping 2.1% from energy alone.  Clearly, this could not be sustained without dire consequences.

Again, I believe the goal is to run rates up as high as possible without scaring (or scarring) the citizens and unleashing any bond vigilantes.  The turmoil in the EM bond markets is already concerning.

With the 2s10s spread already at .25, the Fed has only one more hike, possibly two, before the curve is inverted — meaning nasty recessionary implications.  Therefore, I believe it’s about time to let the air out of CPI and bring it gradually back down to 2% (even PCE is at 2.4%.)

At 65, CL is still 35% higher than Aug 2017’s average price.  RB is about 19% higher than Aug 2017’s average.  As mentioned above — even with the recent decline in futures, there hasn’t been much decline in prices at the pump.  I’ll do the math later this evening, but it seems to me that RB and CL will need to bounce quite modestly off their SMA200s — assuming they do bounce.

As the chart below shows, CL came very close to its SMA200 but has further to fall if it wants to backtest the purple channel again.  Note that SPX has plenty of room to fall if all TPTB want to do is protect the purple trend line, currently at 2780ish.

So, while the SMA200 is theoretically important, it isn’t a hard line in the sand — especially if inflationary pressures arise from other quarters and a more modest YoY input is needed to keep CPI under 3%.

Also, the SMA200 has been breached many times in the past without ill effects on stocks.  The bigger issue might be the yellow TL from 2017’s lows.  Breaking it, if necessary, would definitely send a signal to the algos.  But, it would be mitigated if CL were to bounce at the purple channel top – currently around 62.

RBs SMA200 just crossed the purple channel top — a solid target that hasn’t been tagged yet.  Like CL, if the channel top isn’t enough, there is a great target at 1.8939 — the .618, white channel bottom, purple channel .786 line and red channel midline.

Let’s look at some numbers.  The EIA has reported two weeks of gas price data so far: 8/6 at 2.781 and 8/13 at 2.774.  At an average of 2.778, this is 20.9% greater than August 2017’s average price of 2.297.

July’s YoY increase as reported by the EIA was 25.3% and yielded an all-items annual CPI increase of 2.95%.  The most recent YoY gas price increases near 20.9% were in May (+21.9% Gas, 2.80% CPI), December 2017 (+20.0 Gas, 2.1% CPI) and November 2017 (+20%, +2.2%.)

The rise from December 2017 to Jul 2018 was 2.11 to 2.95, a difference of 0.84 or 39.8% against a backdrop of gas price increases of 15.9%.

Clearly, non-energy CPI has been on the rise in the background. Looking at core CPI (all-items less food and energy) we can still see an increase from 1.8 to 2.4, or 33.3%.

If the background 2.4% were to remain constant in August, then a reduction in the increase of gas price from July’s 25.3% to August’s (so far) 20.3% would theoretically produce an all-items CPI for August that is lower than July’s 2.95%.

So, stable or even slightly higher average gas prices over the next two weeks would probably produce at least a slight reduction in CPI — unless the background core inflation has accelerated quite a bit.

EIA gas prices jumped 11.9% from Aug to Sep 2017.  This helped contribute to a rise in CPI from 1.9 to 2.2%, as core remained level at 1.7%.  All else being equal, then, current prices could rise a bit and still maintain Aug’s CPI levels.

In October 2017, gas prices declined 5.4%.  If prices remained flat, we’d be looking at a 14.3% YoY increase.  Again, it’s a decent argument for prices to remain relatively flat.

Of course, “all else” might not remain equal.  If tariffs are expanded and continue to pressure import prices, core could remain at 2.4% or higher.  In that case, we’d need to see RB dip below its SMA200 in order to avoid 3% CPI and a 3%+ 10Y.

From a trading standpoint, this suggests the SMA200 should be the line in the sand for RB.  Above it, stay long.  Below it, go short for the most likely downside target at 1.8939 — ideally around the Sep 26 Fed announcement.

Let’s take a look at oil prices and see if they confirm the above.  The first thing to note is that crude (WTI) YoY price increases have averaged more than twice those of RB.

Between Feb 2016 and May’s highs, gas prices increased 66.6%.  WTI increased 130%.