Defying Gravity One Round Of QE At A Time

From Nic Lenoir of ICAP

The silver lining is always the same: private GDP has collapsed, and governments around the world are trying to prevent us from falling off the cliff artificially via stimulus, quantitative easing, accounting gimmicks, or data distortion. Earlier this year, the Fed attempted to pull a little bit of liquidity out of the system and let some liquidity facilities mature. Sure enough it was not long before the crap hit the fan. The Eurozone already battling with fiscal embarrassment especially for the Mediterranean members started to struggle even more rolling of debt, and especially USD debt with USD liquidity diminished. It triggered a relapse in credit space sending equity indices in tailspin and bear market territory for a number of indices (as definedusing the moronic 20% rule).

My friend Julian Brigden has long pushed the argument of global liqudity as the main driver of financial asset prices. Thinking about it US equity indices made their highs in late april, at a time when European woes were already long acknowledged: EURUSD turned bearish in December and the Greek scandal dates from last fall. Looking at it from that angle, it is hard to refute that it is liquidity that drives market developments. In a way it goes along the obvious realization that markets' unbelievable rally from the 80's onward was driven by the rise on the debt to GDP ratio, or the observations of S&P market spike on every POMO day in 2009 post 11 A.M.

We have long warned and acknowledged the rollover of Economic activity (curiously following closely the expiry of stimulus programs, quantitative easing, and therefore liquidity injection). However I want to draw your attention toward our global liquidity chart which shows that after allowing liquidity to subside forces in power have addressed the problem and world liquidity is flying towards new highs. There is European QE involved, talks of additional stimulus in Japan, research stating that due to securitization Chinese loans in H1 2010 were 30% higher than officially acknowledged, and yesterday the minutes indicating that the Federal Reserve's board is cosily discussing further securities purchase if warranted. So while the tone was around the end of Q1 that of austerity, letting liquidity facilities expire, and withdrawing "exceptional" accomodation, it appears political will has lasted about as long as my latest experiment with dieting. The difference being the future collapse of the world economy doesn't rely on my eating habits.

I came to piece these thoughts together observing the price action today as equities were under pressure and the DXY was getting pummeled. Certainly this is a departure from traditional correlation between risk assets which are guided by nothing but liquidity and carry trade funding/financing. WHat is interesting here is the big conflict we have between the ramp up in liquidity and the sudden realization that a double dip is pretty much guarantied (barring more stimulus/QE and the likes). Maybe it is precisely this divergence which is leading us to observe weak equities, a weak USD, strong US Treasuries, and commodities are trying to figure out their identity torn between the weak USD giving them a boost and the weak demand.

Technically I think there are a few markets we need to track closely to see if this trend persist and capitalize on it. Equities are consolidating as today's weakness is harldy a concession given the recent advance and they have followed the liquidity rebound. The Nasdaq chart attached shows how yesterday at the close the index was potentially posting a key reversal, but the fact we retraced this PM most of this morning's sell-off invalidates quite a bit the evening star that was in progress. Let's folow closely this index in the next few days and see how this consolidation evolves. The risk in the next few days is that if we end up breaking through the 100-dma after a bit more range trading we accelerate further. The Nikkei future surely makes me lean this way, because we have held a HUGE support at 9,090 and we have potentially completed the last leg of an open-ended triangle which would send us towards 11,500. Surely trading around 9,600 right now the risk reward is tilted in favor of the bulls.

The most money to be made is probably when commodities tell us which way to dance. With equities on the fence and the mixed signals with the attempted evening star in Nasdaq and the bullish formation for the Nikkei, I count on commodities to point in the right direction. Today they are not validating the sell-off in the DXY. Watch for a key break in Copper (see daily chart) to the upside which would trigger an inverted H&S. Conversely, gold (especially looking at the daily chart) has formed a very bearish pattern in Elliott, and if we start trading below 1,202/1,200 we would trigger a bear flag as can be seen on the hourly chart. Watch those two charts to give you a thumb up or a thumb down.

Bonds meanwhile have held their support and shot up. It seems that whether it is because risk is collapsing or becaue the money printed needs to find a home in a low yielding environment and with equities losing retail's favors, the long end of the US fixed income curve is going to remain bid (in terms of prices, not yields). We still think US yields are going to underperform German yields, and the curve is pushing foward with more flattening (see our recommendation a few weeks ago). This is a constant and for now the trend is towards lower yields. The day we get weak equities, weak commodities, weak US Treasuries, and a weak USD... well that day you better to start praying because it means gravity just woke up.

Good luck trading,



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