Submitted by Mark Orsley of PrismFP
Equities continue to trade “well” but the all-important test of 2798 is growing closer by the day. 2798 is important because the trend line connecting that point failed three times in Oct, Nov, and Dec. It would also coincide nicely with my Elliott Wave “5 count” that would speak of an “ABC” correction. Those are minor “cool offs” not substantial sell offs.
However, also recall from my note last week that in the past 20 years, the S&P future has only been this extended to its 50-day moving average two times. Both times saw significant corrections of ~10%.
So if you flew down from the dark side of the moon, ignored fundamentals/positioning, looked at the chart of S&P mini’s, saw RSI’s overbought, and momentum indicators starting to roll over; you would expect some sort of correction near that 2798 level. The only question would be how deep.
However, we know that the market is in a much different place than Oct/Nov/Dec when the Fed unwisely had its foot on the hiking pedal and the equity market was undoubtedly positioned bullish. The data has now softened but the Fed has responded with a pause in its hiking cycle with the market largely de-risked. Voilà, 2800 approaching.
Easily the most misunderstood theme in the market right now is the Fed’s “dovish pivot” narrative. There was a “neutral pivot” and that’s it. If we dissect the Fed speak in the last 24 hours, it’s full of evidence.
Let’s first look at what the Fed’s Mester (leans hawk, 2020 voter) said yesterday:
- Fed has wait and see approach to future moves
- There you go Loretta. That is the company line right there = neutral
- Rates may need to go a bit higher if outlook met
- Hmmm well that is not very dovish. Ok so what’s the outlook?
- Sees economy in a very good spot with inflation near 2%, and does not see a recession in 2019 or 2020
So we can see that Mester, recognizing she leans hawkish, is playing the company line of a neutral stance but with a bias towards more hikes. No dovish pivot there.
Next we got some sound bites from the Fed’s Williams who is moderate and more important than Mester as he is obviously a voter every year.
- Monetary policy was where it ought to be with rates around neutral
- There we go, the typical Fed line these days. Nicely done John.
- The new patient-minded Fed stance did not mean not hiking rates or that policy was set for all time
- Whoa easy John, market thinks you are in a “dovish pivot”
- Expects to be drawing down the balance sheet for some time (noted a move from $1.6t to 1.0t)
Like Mester, Williams delivers the neutral stance but with a clear bias towards more tightening via hikes AND continued balance sheet unwind. So where is the dovish pivot everyone is talking about?
This is important because we get the FOMC minutes today from the “dovish pivot” January meeting. A simple thought is the market is priced for the dovish pivot, so anything less is a disappointment.
- If the Fed can convey a more dovish message than all these “neutral” comments Fed speakers have been delivering, then 2798 gets taken out and my Elliott Wave “5 count” will have to move up to 2900.
- If its neutral and the market finally realizes there is no dovish pivot; then you will likely get the correction the charts are forewarning. Again, the only question would be how severe. A simple ABC correction to say 2700/2650 (2-4%), or a deep 10% correction to blast out the FOMO buyers.
- No chance of a hawkish message so let’s not bother.
* * *
A couple quick hits from around the world….
One central bank that has clearly gone full dovish is the ECB. Chief Economist Praet floated the TLTRO discussion but more importantly also said that the business climate in the Euro area “seems to be changing in a more fundamental way", and adding that "we are not in a vicious circle, but we are close to that."
We can add in ECB members like de Guindos saying that policy will “stay accommodative for a long while.”
Now that my friends is a dovish pivot.
Thus Euribor spreads are topping out and at risk to going completely flat. You should sell ERZ9/ERZ0 at trend resistance.
Does it make sense that US Eurodollar spreads are mostly negative and European Euribor spreads are mostly positive? That means the ECB will be hiking when the Fed is cutting, at a time when the EZ economic data is in a “vicious circle,” and with the ECB utterly dovish/sounding the alarm bells. Something is wrong there. Either ED spreads need to steepen or ER spreads need to flatten, or both.
More of the same in Australia with wages coming in slightly soft last night. There were also reports that home loan delinquencies rose in December and that 90-day arrears are hitting record highs. We have talked about this theme enough but note that Aussie 3yr futures hit trend support and held so you are getting another buying opportunity to play the Aussie housing debacle that will force an RBA dovish pivot.
Lastly, with regards to trade wars, the street chatter has become that there will be either a partial deal with the agreement to continue to negotiate, or a pure “kick the can” style deal (i.e.: 60-day tariff extension).
On the one hand it is another vol killer along with the Fed’s neutral stance. On the other hand, it will allow the global economic data bleed that I have been noting to continue unabated. Additionally, as I have been warning, there are signs already that TW’s have persisted too long. So any extension to draw it out further will only see the data hemorrhage even more as global businesses tighten up with uncertainty.
I believe that to be an out of consensus thought given conversations with clients.