By Nic Lenoir of ICAP
The one market that has not played long too much with the overall risk picture is the FX market. We had highlighted the EURUSD triangle the other day, there is a similar one short term in the Dollar Index. More importantly, we see on a weekly chart that the DXY is shaping a monster inverted H&S, the same pattern we have advocated playing when we recommended buying USDCLP at 505/510. The key lesson from the 90s is that the USD rally killed Asia. With China supposedly the growth engine of the world and a peaking ISM cycle in the US, this is not good news for the global economy.
S&P futures have tested the key resistance this morning around 1,105. We have been highlighting the 1,107/1,113 resistance zone for some time now. A break above is resolutely bullish, but as long as we remain below we could still be in a very bearish formation. On the downside watch 1,067/1,065 as the key support. Below that level the market will go test 1,017 at the very minimum. It is interesting to notice that the Nikkei has triggered the inverted H&S we pointed out the other day. Yet given the prime minister resignation and subsequent Yen weakness, the Nikkei move could be a simple knee jerk reaction to the weaker currency that favors Japanese exports. AUDUSD has not confirmed the break and is still below the 0.8575 resistance. A break past this resistance opens up the way towards 0.89 where all the moving averages have just posted a bearish cross and that type of level is sometimes retested before further downside. If the USD keeps strengthening and EURUSD closes tonight below support however, which is likely given that DXY is breaking out of its triangle bypassing 87.10 as I type, we could see risk come back under selling pressure.
Big picture I remain a convinced equity bear, but we are interestingly at cross-roads here. Which ever way we exit the 1,067/1,113 band will probably turn out to be a very sizable move. If we break to the upside we have the DXY most likely rejecting the inverted H&S at 88.35 and pulling back lower, with AUDUSD breaking north towards 0.89. To the downside EUR will probably get sold very aggressively and DXY will be VERY VERY strong.
The only alternative scenario would be one of strong US equities with weak commodities and Emerging Market stocks. While I favor US equities to outperform their emerging counterparts in a deleveraging environment, it still seems a stretch to have them move in opposite direction. It seems to me inevitable, even if we rally past the 1,113 resistance and wind up making new highs in S&P futures, that deflationary forces will catch up with us. This is a balance sheet contraction environment, debt has overall been only marginally reduced so far and we have a lot more to go to restore some balance in the system. This environment will prove extremely deflationary and since a lot of balance sheets need to be funded in USD it is completely part of the strong USD theme we have been pushing foward since early 2008.
All eyes are on the NFP number coming out tomorrow. I personally believe that the number will match or beat expectations. HOWEVER the jury it out regarding the relevance of a number propped up by a birth-death model and census hiring. This week Citi Financial announced it was closing multiple branches and HP is going to reorganize 6,000 jobs and terminate an additional 3,000. Jobless claims are also not really painting that cheerful a picture, and neither did ADP earlier today. That's right even HP is still not done cutting jobs even though the stock is still up almost 100% from last March's lows and I am sure analysts are trampling each other to upgrade the price target. My macro view is that the global economy is imbalanced and too many jobs in the US are services which only thrive when the stock market is booming and the wealthy spends lavishly (do you seriously need a massage and a beer brought by someone you tip $20 every time you get a haircut?). Since we no longer have the possibility to run our economy on credit, we have reached the tipping point where we need real jobs to support growth otherwise without a strong middle class spending will drop and to make matters worse people will rely on asset sales to support whatever spending they still engage in as the political capital to use federal funds to maintain the economy afloat vanishes.
While tactically we will stick tactically to the 1,067/1,113 game plan, I don't think that there are any outsized returns coming any time soon playing the market from the long side.
Good luck trading,