Intraday Market Thoughts Archives
Displaying results for week of Jul 04, 2021Reflation Trade Deflated But Not Defeated
We say it often but it's worth repeating today: Listen to what the bond market is saying. Falling yields spilled over into a broader risk-off trade Thursday with global stocks sinking and USD/JPY dropping a full cent.
This move has been brewing for awhile but market participants are utterly puzzled by the lack of fundamentals underpinnings for the drop. We've highlighted the Fed but it's a stretch and the delta variant is a known unknown so that's a hard sell as well. Bond traders continue to point to positioning and liquidity, which is why we will be watching how upcoming Treasury auctions are digested.
Adding to the puzzle was glimmer of a turnaround in New York trade as 10-year yields bounced off the 200-dma we highlighted earlier in the week. 1.39-40% now becomes the new resistance, but vulnerability towards more downside remains for near the 100-WEEK MA at 1.21%. The dollar stabilized soon after and bounced, stocks followed. Oil also finished higher on the day in a sign that trade is washed out. Copper has been flat for three weeks and isn't reflecting any newfound growth fears.
The best advice might be to roll with the technicals and manage risk until the price action and fundamentals converge.
One spot to watch especially closely is CAD. The Canadian jobs report is due on Friday followed by the BOC next Wednesday. That's a live meeting with a genuine taper likely. The loonie is also at the nexus of the oil and risk trades. The consensus is for a healthy 195K jobs and 7.7% unemployment from 8.2%. Lockdowns were eased in the month so it could be a good one, though July/Aug is set to be even stronger.Slow Motion Tantrum & VVIX
Equities dip in a broader bout of risk-off on a combination of travel advisories in Europe and extended selloffs in overvalued indices (DOW's inability to break above the 34800 high, or divergence from DOW Transports). The relentless bid in bonds continued on Wednesday as the paradigm of bond and USD strength continued. CHF and JPY are the strongest, followed by EUR, while NZD and AUD are at the bottom. US initial jobless claims came in higher than expected (373K vs exp 350K). Ashraf kept reiterating the message to the WhatsApp Broadcast Group Members: "As long as you're long EURUSD, stay short AUDUSD as it would set up for a rally in EURAUD" and that is exactly what's happening. The long USDJPY trade did not work out well, but it was later compensated with longs in USDCAD and shorts in US500. This risk-off is not stopping soon. This VVIX/VIX chart was shared with our the Group earlier. For an explanation on how to use/read the VVIX/VIX, please see this video.
Convincing explanations for falling yields remain elusive with technical factors and a short squeeze getting much of the play. One factor that can't be ignored is the Fed. The drop in yields accelerated after the June 16 FOMC and that's not a coincidence.
The kneejerk reaction was to push yields higher on a taper but the message now is that the Fed is flirting with a policy mistake. That they could taper/hike as growth slows and temporary inflation recedes.
The FOMC minutes underscored the delicate balance. They said a 'substantial majority' of participants judged that inflation risks were tilted to the upside while 'various participants' mentioned that conditions for a taper would be met 'somewhat earlier' than anticipated.
In a sense, this could be a different kind of taper tantrum. Technically, there isn't much support until 1.23%, where the 200-day moving average currently resides.
Where it gets interesting is the reflexivity embedded in the Fed. They cheered rising yields earlier in the year and will be cognizant that yields and breakevens traders are now betting against their ability to generate 2% inflation. Beyond that, there's a conundrum that Fed and other central bank buying may be what's pushing yields down – not inflation expectations.
Ultimately though, the only way forward is to watch for headlines, economic data and technicals, which is what we will continue to do. July signals are often hazy so we have no expectation that this puzzle will be solved any time soon.
Those Minutes & Bonds Versus Commodities
US 30-year bond yields fell back below 2% on Tuesday and 10-year yields took out the post-Fed lows. Some in the bond market continue to point to a short squeeze but that's tougher to believe a second time.
It's summer and the puzzle pieces don't always fit but at face value the drop in yields and breakevens is a negative for a wide swath of trades. The backbone of the commodity and commodity FX trades is high growth, low rates and rising inflation. That the bond market is increasingly comfortable with returns well below the Fed target is troubling.
That was reflected in commodity FX Tuesday and most commodities, including the sharp reversal in oil.
We hate to bet against the bond market but economic data highlights why it's too early to cast aside inflationary narratives. A miss in the ISM services data at 60.1 vs 63.5 kicked off the flight to safety but the internals of the report told a different story. A shift to less-positive sentiment was about margin pressure, capacity constraints and inflation. The 'order backlog' component rose to 65.8 from 61.1 and imports to 58.2 from 50.4. Comments in the report also highlighted severe supply chain disruptions.
Ultimately, either commodities will have to fall further or rates turn back higher. At the moment, rates are winning but there are many chapters yet to be written.
One of them will be Wednesday when the Fed will release the minutes of the June FOMC meeting. Chances are the commentary in the report is less hawkish than the dots suggested. Powell indicated that policymakers didn't even discuss the dots. At the same time, market participants will be feverishly scanning the report for taper talk.
