Saturday, July 31, 2010

T−Bonds and Gold Signal Impending Stock Market Break

Treasury futures rallied in flight-to-safety buying as yields in the 30-Year Bonds and 10-Year Notes plunged. Expectations are the Fed is likely to keep interest rates down for a prolonged period of time. Despite the early recovery in the equity markets, the Treasurys held their ground, suggesting that there is real concern about the condition of the economy. The fact that Fed officials are backing the call for a weaker economy is the key driving force behind the move in the Treasury instruments. Traders have decided that the Fed is likely to keep pressure on interest rates until the economy can turn around.

Something has to give in either the equity or fixed income markets. The T-Bonds and T-Notes seem to be the best indicator of the state of the economy. This means that the pressure should be on the equities.

The fact that December Gold rallied on Friday is a strong sign that money is leaving the paper assets (stocks) and being reinvested in the hard assets (gold). Although gold could not post a weekly closing price reversal bottom, the pattern looks positive for the start of a retracement rally. All it needs right now to trigger a rally is a weaker Euro and stock market.

U.S. stock indices traded lower following the release of a weaker than expected U.S. Second-Quarter GDP report, but quickly turned positive after value-seekers stepped up to buy at cheaper prices. After the initial surge, the markets stalled, setting up the possibility of a lower trade into the close. Trading conditions continue to remain volatile as traders jockey for position into the end-of-the-month close.

Technically the September E-mini S&P 500 closed lower for the week, setting up the possibility of a weekly closing price reversal. A confirmation of this pattern suggests the start of a 2 to 3 week correction back to 1060.75 to 1047.00. This morning’s rally stopped short at last week’s close at 1100.50, indicating that the Bears are defending this price level.

This week the September Euro penetrated the 1.31 price level for the first time since May. The primary driving forces behind this move were the better outlook for the Euro Zone economy and the weak outlook for the U.S. economy. The data out of Europe may have brought the European Central Bank closer to a rate hike than the Fed.

The September British Pound closed near the high for the week after piercing a major 50% price level. The strong close put the market over 50% of the 1.7042 (July 2009 Top) to the 1.4229 (May 2010 Bottom) range at 1.5635.

Weak U.S. economic data and a better outlook for the U.K. economy are the reasons for the strength in the Sterling. While the U.S. is still on a spending spree, the U.K. has been busy implementing austerity measures while reading for tax hikes. Bullish traders seem optimistic that these two factors are good for the economy but some traders remain skeptical that spending cuts and tax increases will curtail the economic recover.

Comments from the Bank of England this week seem to suggest that it remains cautious about the economy and is willing to continue to provide stimuli if and when necessary. Recently it was reported that the U.K. GDP rose more than expected. This provided some lift to the market but poor housing numbers seem to indicate that the central bank is still far from hiking rates.

The Australian Dollar finished near its high for the week after a two-day setback. Demand for higher risk assets was the driving force behind the rally. Earlier in the week, the Aussie weakened because CPI data suggested the economy had cooled off. This meant that the Reserve Bank of Australia would most likely refrain from hiking interest rates at its next meeting on August 3rd. Friday’s rally suggests that speculators are driving up the market because of the weak U.S. economy and the likelihood that U.S. interest rates will remain at historically low levels for a prolonged period of time.

The New Zealand Dollar closed higher on Friday after a closing price reversal top earlier in the week triggered a 3 day, 50% correction. This move is typical during a rally. The main problem, however, which suggests lower markets to follow, is the weekly closing price reversal top.

Fundamentally, the Reserve Bank of New Zealand hiked its benchmark interest rate by a quarter-point to 3.00%. The RBNZ, however, said it would most likely refrain from another rate hike because of expectations of slower growth. This news triggered the sell-off in the Kiwi. Technically, the reversal top could be a bearish sign if confirmed. The chart suggests a possible correction to .6980 over the next 2 to 3 weeks.

The U.S. Dollar traded mostly higher against most major currencies overnight but gave up some of its earlier gains early in the New York session, turning negative against the British Pound, Australian Dollar, Canadian Dollar and New Zealand Dollar while only giving up ground to the Euro and Swiss Franc. The Dollar traded weaker versus the Japanese Yen all trading session.

This morning the U.S. GDP Report showed the economy grew at 2.4% in the second quarter. This growth was at a pace somewhat slower than pre-report estimates of 2.5% to 2.7%. A first quarter revision higher may have been the reason for the limited reaction to the downside in the equity markets and the reason why the rally stalled in the Dollar.

The biggest concern at this time amongst investors is the uncertainty of future growth. Continuing to lose growth at the current pace suggests the U.S. GDP may fall below 2% during the third quarter. This uncertainty is one of the main reasons why employers may be curtailing hiring, thereby exasperating the employment situation in this country.

In other reports, the Michigan confidence index was revised to 67.8 in July and manufacturing activity in Chicago rose more than expected. The Dollar was able to hold its ground following the release of both reports.

The overnight strength in the Dollar against the majors except the Japanese Yen was triggered by weak Japanese economic news. Overnight it was reported that Japanese core consumer prices fell 1% from a year ago. May industrial production and employment were also negatives.

The Dollar strengthened further after Fed voting member Bullard said the U.S. “is closer to a Japanese-style outcome today than at any time in recent history”. He also said the best remedy for this developing problem will be another round of Treasury purchases by the Fed.

Stocks were expected to trade lower today, but a quick rally following the opening, triggered by value-seeking bottom pickers helped drive the equity indices higher. This forced short-covering rallies in both the New Zealand Dollar and Australian Dollar.

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