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| International Monetary Fund's Managing Director Dominique Strauss-Kahn (L) talks with , European Central Bank President Jean-Claude Trichet (C) and Italy's Governor Mario Draghi (R) prior to the start of their G-7 meeting at the Istanbul Congress Center (Photo credit: Wikipedia) |
The Fed and the ECB have given us clear guidance within this crisis era, that they will do anything and everything to prevent more shocks. They will spend money they have. They will promise money they don't have. They've set a precedent (albeit a dangerous one).
Why does it work? Because everyone is troubled, and everyone is vulnerable. In normal times, money would punish the troubled and move toward stability and sanity. But these aren't normal times.
That's why all global policymakers (central banks, governments) have proven that they are willing to stand behind each other when needed. China steps up and buys Greek debt when Greece is imploding. The Fed steps up and supplies the world with unlimited dollar liquidity when European banks are on the verge of collapse. These are a few examples of many.
It's important to understand, it's not that they want to help, necessarily. It's because they have had to.
The stool cannot stand if one leg falls. That remains the case, six years into the crisis.
Now, we've had plenty of bad interpretations on the future path of Fed policy over the course of this crisis-era. The events of the past few months have been just more of the same. The Fed has tried to tell us openly what they are thinking. Still, no one likes to listen.
Oddly enough, perhaps the biggest mistake people are making currently is paying too much attention to the Fed. And they are paying too little attention to the rest of the world.
Whether or not the Fed scales back its OPEN-ENDED QE program is not that important. What's important to understand is that the rest of the world is, and has been, spiraling lower again -- for the better part of the past year.
And, while people have become accustom to watching the Fed for guidance, the guidance on global monetary policy juice is coming from Japan, not the Fed. And more is about to come from the euro zone and the UK.
So those that are fearing that less Fed stimulus means less fuel for economies and asset prices, wake-up. The BOJ has unleashed one of the biggest (if not the biggest) global stimulus programs we've seen in this crisis-era. And its in the very early stages. And the BOE and ECB will likely get as aggressive as they have been to respond to the ultra-weak economic conditions in Europe.
This creates an environment that is highly positive for global stocks. And it creates an environment that is highly positive for the dollar as we get incremental divergence in the policy paths of the Fed relative to just about everyone else.
Now, let's take a look at the charts ...
EURUSD
Let’s take a step back and look at the long term chart of the euro. In this monthly chart below, you can see the trend remains lower. In fact, we’ve been in a five year downtrend in the euro, following the marking of its all-time highs versus the dollar in 2008.
Looking back to the 2008 high, we have a series of lower highs along the way. And we remain in the bottom third of this 42 big-figure range of the past five years. The 200 month moving average in the euro, comes in right around 1.20, which also happens to be right around the mid-point of the all time range in the euro (dating back its 1999 inception).
So despite all of the threats to the existence of the euro, all of which remain valid, the euro continues to trade in expensive territory, relative to its historical range. So the trend remains lower, and its worth noting, the moving averages on the weekly are bearish.
Now, narrowing in a bit on some of the more recent behavior of the euro,
In this weekly chart, we can see that the 0.618 retracement of the move down from 1.4939 to 1.2041 came in at 1.3832.
This most recent retracement leg fell just shy of that 0.618. Of course, this retracement leg was driven by verbal intervention by the ECB a year ago, when Draghi said they would do “anything to save the euro.”
The high of the move marked the head of a bearish head and shoulders (see the chart below). After forming a right shoulder, the first attempt to break the neckline failed. It’s very common to see head and shoulders patterns elicit volatility, and that was the case. It failed the neckline and bounced aggressively.
But as you can see in the chart above, we still have a very compelling bearish head and shoulders structure. The neckline now comes in at 1.2820 – the break of which would project a move down to 1.18, which happens to match the crisis-driven lows in the euro (i.e. the low of the past five years).
So based on the analysis of the longer term charts, things continue to look bearish for the euro. Now, let’s take a closer look…
In the chart above, we see the sharp move lower from mid June, driven by the reaction to the Fed’s most recent meeting. The market was looking for taper talk, they got it, and they bought dollars on it. Of course, cutting back on QE would push the Fed in a direction opposite from the rest of the world, which is dollar positive. However, a portion of this move was erased a few weeks later after the Fed ensured everyone that they would remain in aggressive easing mode, whether they scaled back QE or not.
Nonetheless, given that the other major central banks are initiating MORE easing, the relative policy implications (which are THE drivers for markets right now) are firmly dollar positive – taper or no taper. This creates a very good area to sell euros against to look for an eventual break of 1.2750 on the downside. Expect very good selling against 1.3205 (the high of the Bernanke driven spike). The downside trade would only be invalidated if we get a break of 1.3325, the line from the May 2011 highs that describes this downtrend.
On the downside, the 1.2750 area is huge. Of course, 1.2743 was the low marked on April 3rd when Draghi was speaking, and stopped to make this point: He said people have underestimated how important the euro is the euro zone. That turned the euro for some time. And that level has held nicely a few times since, over the past three months. Expect the Nov 2012 low of 1.2659 to go quickly if 1.2743 gets taken out.
GBPUSD
So now we have Carney well in place at the BOE and things are playing out according to expectations. This has been an event people have been waiting on for the better part of 2013.
In his first meeting as BOE chief, he didn’t disappoint. He laid the groundwork for taking a more Fed-like approach to policy, which means telling people they will be ultra-easing for an extended period of time (or some language to that effect), and ramping up policy to deal with the lack of growth in the UK. Among that policy, expect them to set thresholds, as the Fed has done on unemployment and inflation.
So what does it mean? Sell cable on rallies.
For those of you that have read my Big Picture piece for some time, you’ll recall this huge four year line the chart below, that we were looking to break.
That level gave way back in February and led to another visit under 1.50. And on this retracement from March through May, we were looking for this line to hold -- which it did.
With policy changes coming in August, look for this key 1.48 level to test and go. This opens up a move down to 1.42 in the pound. Look to sell strength and sell weakness.
USDJPY
As I said earlier, the BOJ policy shift made back in April is huge! This weekend we get more confirmation that Abe's policies to end deflation in Japan will roll on -- his LDP party gained a majority in parliament. As I laid out in my piece, Japan: The Trade of the Decade, expect a much weaker yen and much higher Japanese stocks. The BOJ has told us explicitly, they are factoring in a persistently lower yen and persistently higher stocks.
In the chart below, you can see we've gotten a 38.2% retracement of this strong uptrend in USDJPY, that was initiated by Kuroda's comments (prior to becoming BOJ gov) that he thought Japan should target aggressive inflation. Strong trends have shallow retracements. That's the case here.
Yields
Don’t get so excited about yields. Each time the Fed has done QE yields have risen!
In my last piece, I showed the below chart on U.S. 10 year yields and made this comment: “you can see that QE has pushed 10-year yields higher in each case. In general, with the Fed telling investors that they will push rates lower, it has created the opposite effect. It has driven people out of bonds (i.e. encouraged them to sell) which pushes bond yields UP.”
The below chart is from my June 17 piece …
Yields have continued to extend into this, running into this trendline (the falling red line).
The next chart is current and shows the most recent climb in yields – the line represents just closing prices.
You can see in this chart above, we’ve had an aggressive rise in yields since the June Fed meeting. But we have run into technical resistance here. And there is little fundamental reason to expect yields to continue a march higher anytime soon. Back in my January 13 Big Picture piece, I argued that, given the improvements in the economy and given the Fed had promised to ward off any future shocks via its open ended QE, that we had probably seen the low in yields and would likely find a sustained new range above 2%. I said, “That’s probably good enough to move U.S. yields into another trading zone, perhaps 2%-3%, instead of 1.5%-2%. That likely means, the all-time low of yields is IN. And that creates the risk the move in yields could be quick, as it opens up the floodgates of Treasury sellers”
Where from here? We likely stay in this 2-3% range. Japanese institutions are now plowing money into U.S. stocks and U.S. Treasuries escaping the yen devaluation policies in Japan. That should keep a cap on yields. Inflation remains uncomfortably lower for the Fed. That’s all a formula for a halt in yields.
Japanese stocks
We've had a nice retracement in Japanese stocks -- a second chance for people to get involved. With the monopoly Abe has in parliament now, expect another leg in this Japan trade to kick in. In this chart below, you can see this key trendline that held the first run up at 16k. That 16k level in the Nikkei now becomes the big break point.
The bigger target above is 23k -- which we could see in the next twelve months if the BOJ is executing their plan effectively.
That’s it for now. Have a great trading week.
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