The Trader: A game of two halves

Economy vs markets

The Fed gave a bullish outlook on the economic recovery this week, but left its dovish course of monetary policy unchanged. Perfect conditions for a market rally, some might say. After stocks in the US closed at record highs on Wednesday following the statement, the reckoning came on Thursday. Yields popped, nobbling tech stocks: the US 10-year Treasury yield rose to 1.75 per cent, the Nasdaq fell 3 per cent. The downbeat mood rippled across other markets and left all the major indices lower, Asian markets fell and Europe has opened in the red. The FTSE 100 is weaker as heavyweights BP and Shell fell in the wake of yesterday’s oil price plunge and HSBC declined 2 per cent. 

It looks like a classic case of rates go up, growth stocks fall. Cyclicals didn’t really benefit though – it is not a simple case of moving from one part of the stock market to another. Nevertheless, I think this is part of the natural churn we are going to see in stock markets as they respond on a daily basis to rises in bond yields. This is not about absolute levels – not yet at least – but about the pace of these moves in bond markets which will take out bulls and bears alike with the gyrations. These shakeouts will create new entry points. As I said after the FOMC meeting, the Fed and its chair Jay Powell are letting the dogs of inflation off the leash and this creates all kinds of tensions in markets. Yields and inflation expectations are going to rise – the Fed is explicitly telling them to do so. It couldn’t really be any clearer: the Fed wants inflation and yields to rise. It’s technically behind the curve, but wilfully, gleefully. It’s behind the curve in the way a driver of car steers his car round the bend looking firmly at the road ahead and knowing there are chicanes coming.

If the Fed wants to run the economy hot, the latest Philly Fed index suggests it’s already there. The index for current manufacturing activity in the region jumped from a reading of 23.1 in February to 51.8 for March its highest point in nearly 50 years. The current new orders index also increased to a 50-year high, rising 28 points to 50.9 in March. And inflation again reared its head as firms reported price pressures from purchased inputs. The prices paid index rose from 54.4 to 75.9, its highest reading since March 1980. These kinds of readings are going to become normal over the next few months and see pressure on yields – the big question is at what point the Fed breaks and concedes that this is not just a transitory blip. I don’t think it will buckle and this ought to exert much greater pressure on yields, potentially leading to some kind of ‘tantrum’ and creating further volatility in stocks, particularly growth and tech.

Yields vs purchasing 

The Bank of England was unchanged. The MPC didn’t provide any push back on yields but this just chimes with what the governor, Andrew Bailey, has been saying. It also didn’t want to play up to market expectations for a hike next year. Overall, I call this a holding statement until we get more info on the recovery. 

The Bank of Japan has widened its yield curve target, increasing the size of the band within which it allows longer-dated yields to move. JGB yields moved higher in response. The BoJ also said it would no longer commit to buying ETFs at an annual pace of 6tn yen, instead saying it would only purchase these assets when necessary. Both moves are attempts to give the central bank more flexibility and make its stimulus more sustainable in the wake of the pandemic as it tries to stimulate inflation. February core CPI inflation fell 0.4 per cent year-on-year, signalling a decline in the rate annual declines in consumer prices for the second straight month, as rising fuel costs offset the drop in household spending.  

Oil vs gold

Oil prices are higher after they tumbled yesterday in a brutal sell-off for complacent bulls. Demand fears maybe, rising inventories maybe; certainly, some lack of momentum after Brent hit $70 was a factor. I don’t think it is going to mark a reversal for bulls, more of a shakeout as the summer looks set to see strong demand again. Nevertheless, we had noted that the nearest months flipping to contango was a signal there are some fears that the market right now is not as tight as it might be. WTI dropped to touch its 50-day moving average and is firmer this morning. 

Gold still trades with the bullish MACD crossover in oversold territory on the daily chart supporting the bulls. On the hourly chart we see a firm bounce off the 200-hour simple moving average plus MACD crossover and trend supporting the thesis. Bulls require to take out the swing high at $1,756 with the big resistance at $1,760 before a return to $1,795/$1,800.