Less than 24 hours to go for the BoJ decision, and about 30 for the FOMC’s.  And, equities are ramping again in eager anticipation of a non-event.  QE, QQE, ZIRP, NIRP, ETF purchasing, VIX, CL, TNX and currency manipulation got us here.  Without them…well, the “market” would rather not think about that.

Kuroda and Yellen are stewing in that knowledge this morning — keenly aware that the whole house of cards could collapse if they do the “wrong” thing — whether or not the economic circumstances dictate.  VIX’s manufactured sleeper of a decline belies the fireworks just ahead.

So, we’ll take a look at the upside and the downside cases this morning — laying out specific targets representing good, bad and ugly scenarios.

continued for members…

First, a round up of the major charts.

CL is looking rather weak this morning — perhaps readying itself to support the next wave up for stocks?  Remember, API will release its inventory data today.

While, USDJPY soldiers on as though it hasn’t a care in the world.

Note the formation of a falling channel which is parallel to the one USDJPY “broke out” of.

DX is clinging to its advances in spite of increasingly slim odds of a tightening.

The scenario laid out in yesterday’s update on the dollar — a weakening euro — is off to a good start.

And, despite weakness during the day and at the close, ES and SPX managed to hold on to their rising white channels.

UPDATE:  9:37 AM

Fading the overnight ramp here at 2147.84.  USDJPY and CL are both sliding.  Initial objective is to close this morning’s gap at 2142, and then test the white channel bottom at 2140.

UPDATE:  9:59 AM

VIX is edging lower.  I’d abandon the short here and revert to cash.

USDJPY and CL are both looking weak, though CL briefly spiked .59 after testing the red.618 at 43.07 — the same one it bounced off on Sep 1.  If it starts making new highs li yesterday, it’ll carry stocks higher.  But, recall that it never could break out after peaking at 10:20, 11:10 and 11:30.  It’ll probably do the same thing today. This is probably as good a time as any to get into the scenarios for the next day or two.

First, let me lay a little conspiratorial groundwork.  When we talk about TPTB, that generally includes all central banks, their commercial and investment bank overlords, and the big hedge funds.  I don’t usually include big asset management firms such as Fidelity or State Street, only because they are less actively involved in manipulating markets.

But, at times like this, TPTB are less unified than usual.  Commercial banks would love higher interest rates, so they say.  Though, I think that’s mostly a smoke screen to explain away the lack of interest in lending.  Their investment banking, M&A, corporate finance, etc. divisions recognize that business is better when stocks aren’t tumbling.

The hedgies are, in the aggregate, rate hike agnostic.  Those that are closet indexers might like to see rates stay the same, while directional traders don’t really care — as long as there is movement.  Predatory and closet-HFT hedge funds are also ambivalent.

The central banks themselves surely see the writing on the wall.  Inflation has been explained away and, more insidiously, defined away, but it’s real — especially in places that hit consumers the hardest: food, housing and oil.  One way to do so, as we’ve discussed many times, is to prop up the US dollar.  The easiest way to do that is by raising rates.

And, there’s the problem.  They interrupted the Great Financial Crisis with all their intervention, but they didn’t make it go away forever.  Withdrawing that intervention, or even hinting that it’ll be withdrawn, will let the downside resume – albeit from loftier heights.

We saw the effects of a tiny rate increase last December, and it wasn’t pretty.  SPX fell 12.7% from its post FOMC-ramp highs.  But, let’s contrast that with the Brexit fallout — only 5.8%.  Granted, the first rate increase in almost a decade carries more weight than a little-understood/appreciated reshuffling of pieces on the euro chessboard.  But, I also believe the Brexit recovery to new highs demonstrates how adept TPTB have become at managing fallout.

This brings us back to the Fed’s decision (we’ll circle back to the BoJ.)  I mentioned a few weeks ago that I thought they’d tighten if stocks had climbed to new highs.  At 2200, a 5.8% decline would be 127 points, or 2072.  It wouldn’t be a disaster — especially if we got a quick bounce back to 2138.

But, SPX is at 2141 – not 2200.  I know it seems like I’m splitting hairs, but 5.8% from here would be close to testing the psychologically important 2000.  Whether or not the FOMC is aware of the significance of 2138, they’re certainly hip to the importance of 2000.  Would they take a chance, when all they really want to do is prop up the dollar so they can avoid most of the inflation coming down the pike?

The other players mentioned above have been very smart about reinforcing that message.  By keeping stocks at or near their support, they’ve made the Fed think.  And, if they’ve played their cards right, they’ve made the Fed flinch.

At a few points above last year’s highs, there is no room for a decline.  Any decline.  They sacrificed a few months of rising stock prices for a few more months of ZIRP.

If the Fed stands pat, as circumstances and the latest economic news indicates they will, the relief should translate into higher stock prices.  2200 would be a good initial target.  But, it depends on how they get there.

If, as we discussed in yesterday’s DX update, it happens via a CL rally and EURUSD dump, then it will be limited only by how high they can let CL go — which has a lot to do with the passage of time.

On Aug 24, 2015, CL started bouncing.  It didn’t top out until Oct 9.  This means that any year-over-year inflation measurements had to deal with those prices.  The upshot is that any rise from current levels can’t exceed the year-ago prices without contributing to rather inconvenient inflation figures.

As the US eases into stagflation (my personal expectation, going back to Aug 18, 2011) an increase in the price of energy will really start to bite.  So, TPTB can increase CL until Oct 10 or so, at which point they’ll need to start letting it back down.

This would put CL around 52-53 by Oct 10, and back down to about 27 in Feb 2017.  It’s a vastly over-simplified scenario, to be sure.  But, the more I look at it, the more sense it makes.

Consider that October is often not a great month for market performance.  The 2007 peak, for instance, occurred on Oct 11 after reversing an earlier downturn that started in July and should have kept going — sort of like the Brexit downturn this past June.

Other notable Octobers included the 1987 flash crash, the 1990 bottom, the 1997 Asian contagion correction, the 1998 mini-correction, an interim 2000 tech bubble bottom, and another in 2008 following Lehman’s bankruptcy filing.

Since we’re going with the no rate hike scenario for the moment, it’s fair to say the dollar won’t rally much.  At best, they’ll be able to keep it from crashing (by crashing the euro, instead.)  If so, I’d expect the USDJPY to drop.  First, DX and CL tend to be negatively correlated.  But, more importantly, USDJPY usually takes advantage of CL rallies to reset lower — the notable exception being when everything is heading lower in a panic.

If CL is going to rally strongly between now and mid-October, I’d look for USDJPY to drop during that same period.  It has been declining in a very well-formed channel for quite some time, and has resisted every opportunity to break out.

It’s breaking down further today, and looks very likely to test 100 by mid-October.  To achieve this won’t take much: simply, a failure to expand QQE.  NKD is above the SMA100, with nice channel support down at 15809 and 15449.  I don’t think it’s at risk from a failure to expand QQE.  The BOJ can also step in and buy more ETFs if it slips too much — which it would if the FOMC raises rates.

BASE (GOOD) CASE

If we put this all together, my base case is this:

The BoJ and FOMC both stand pat, with the BoJ possibly increasing equity purchases (but shifting to TOPIX from NKD) and the FOMC pounding the table on a December rate hike to help prop up the USD.

EURUSD will drop through its SMA200 and CL will rally strongly enough to keep stocks on the rise, reaching 52 or higher by Oct 10.  DX will muddle along, possibly reaching 92.53 or 93.11 on the initial news before euro weakness props it up.

USDJPY will sell off initially, reaching 100.50 or 100.08, before recovering through Oct 10, at which point it will recover.  If it breaks 100, the next support isn’t until 94.83.

SPX is a little tougher. I’d look for SPX to reach 2214-2223 by Oct 11.  With the election less than a month away, I imagine the polls will determine what happens next.  If Trump is leading by much at all or gaining momentum, I’d look for stocks to start selling off — reaching at least the SMA200 which, by then, should be around 2068.  If he’s behind by much and is losing momentum, I think SPX is more likely to stay relatively flat through Nov 8.

I base the above on the belief that Trump represents a threat to the Fed’s autonomy and authority.  If investors expect him to prevail, this would undermine: (1) their belief in the Fed’s ability to prop up markets in 2017, and (2) the Fed’s interest in propping up markets.  It makes a more compelling narrative if stocks start dropping on the expectation of a Trump presidency.  I believe the Fed will pull out all the stops to ensure Trump is not elected — whatever that takes.

I expect the Fed to raise rates after the election, regardless of who wins.  The only caveat is that if Trump wins and the market has already sold off significantly, the Fed would probably hold off on a rate hike.

BAD CASE

This one’s pretty straightforward.  BoJ eases some, but the Fed raises rates.  If this happens, it means they collaborated to mitigate the fallout.  The dollar would strengthen significantly, so we’d still get a sell off in EURUSD and a very strong rally in USDJPY.  Since the yen would be worth less, CL would also need to sell off.  Stocks would likely fall significantly within a few days — perhaps testing 2088 fairly quickly.  If it failed, then 2058 is a good possibility.

UGLY CASE

BoJ stands pat, and Fed raises rates.  Nowhere to go but down.  DX would shoot up quickly, but CL and SPX would tank.  2058 is probably a given, with a decent chance of 2000 and, if that fails, 1956.

 

UPDATE:  12:50 PM

Quick aside, SPX just finally reached the SMA5 200 at the white channel bottom.  This should serve as the bottom for the day for anyone who wants to play along.

It took a breakout by VIX to get SPX to this point.  So, watch for a reversal for confirmation.

UPDATE:  12:59 PM

No reversal, but a further drop on VIX’s spurt higher.  This feels a lot like a head fake, but there’s nothing wrong with playing along as long as you use tight stops.  Shorting here.

UPDATE:  1:27 PM

It was likely a head fake.  No follow through as yet, so I’d ditch the short here just so I can refocus on the big picture continued up above.

 

 

 

 

 

 

 

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