Jump in Yields Didn’t Derail Equity Rally While Sterling Rallies Ahead of the Weekend on (misplaced) Brexit Optimism

The most striking thing about last week’s price action was the surge in US yields.  The 10-year yield jumped about 34 basis points, the most in three years and returned to levels not seen since August 2 (1.90%).  A deluge of investment-grade corporate bonds and US Treasuries ($78 bln auctioned to lukewarm reception), coupled with an acceleration of core CPI (highest in 11 years), optimism on the trade front, and Mnuchin’s insistence on pushing forward with an extra-long bond, (50, and possibly 100 year-maturities), though has been repeatedly advised against it by primary dealers, were among the potent drivers. There was a dramatic shift from fixed-income funds to equities funds according to some industry reports.   

Part of the rise in the long-end can be attributed to swings in sentiment about the trajectory of overnight rates.  The implied yield of the January 2020 fed funds futures contract rose 14 bp last week.  The market has assumed next week’s cut, which would be the second cut here in H2 19, and a third one.  The issue had been the fourth one, and the market priced it out last week, and for the first time in over a month, the market is a small doubt about the follow-up one.  

The US dollar had a mixed week.  Sterling led the advancing currencies with almost a 1.8% gain.  Full three-quarters of the rally took place in the last session ahead of the weekend amid some hopes that a work-around the controversial backstop may be reached.  We remain skeptical that the circle can be squared, which is to say the border between the EU and the UK cannot be between Northern Ireland and the UK. But if it is between the UK and Ireland, there must be a backstop to preserve the previous treaty commitments the UK made to an EU member (Ireland in the Good Friday Agreement).

The rise in yields and perhaps some optimism on the trade front weighed on the Japanese yen.  It lost 1.1% against the dollar and nearly halved this year’s gain (to 1.4%).  It was the biggest dollar rally in a week since January.  The euro rose for the second consecutive week for the first time here in Q3. It rallied even after the ECB delivered a rate cut and an indefinite expansion of its balance sheet at a 20 bln euro clip a month.    

Dollar Index:  The net loss for the week was about 0.15%.  The year’s high set on September 3 a little above 99.35 was approached in the knee-jerk reaction to the ECB’s decision on September 12, but its reversed lower and tested the 98.00 support area ahead of the weekend.  This area corresponds to last week’s low and some lows/highs from late August as well as the (61.8%) retracement of the leg up that began on August 23.  However, the downside momentum faded as it was approached.  A break would allow another cent decline to stronger support and the 200-day moving average.  The Slow Stochastics seemed to pick up the loss of momentum ahead of the weekend.  Gains through 98.55 would raise a yellow flag to the new-found bears while a move through 98.70 may signal a resumption of the rally.

Euro: The euro drifted lower ahead of the ECB meeting when it initially sold off to test the 2.5-year low set on September 3 (~$1.0925).  It reversed higher and made a new week high and closed above the previous session high.  There was follow-through euro buying that lifted it to almost $1.1110 before the weekend.  The buying seemed to dry up ahead of the hurdle we noted last week in the $1.1120-$1.1125 area. The MACDs and Slow Stochastics are moving higher.  An important question is: How much of the gains does the euro pare before concluding the upside correction is over? As we head into next week, we would suggest a move below $1.1040 now would be an early sign.

Japanese Yen:  The dollar has recorded higher lows against the Japanese yen for eight days running.  It rose every session last week and seven of the previous eight sessions.  It does not seem coincidental that the yen is weakening as US yields jumped.  The yen and US Treasuries appeared to have been linked in numerous financial structures.  The dollar bottomed in late August a little below JPY104.40 and last week closed above JPY108 for the first time since the end of July.  The next big target is JPY109, but the August 1 high of JPY109.30 when the US dollar posted a key downside reversal.  The 200-day moving average is a little above there (~JPY109.45).  The dollar has been climbing up and fraying the upper Bollinger Band, and the MACDs and Slow Stochastics are stretched.  The signal seems to be not to chase the dollar higher.

Sterling:  The nearly 1.8% gain was sterling’s biggest weekly advance in four months.  It closed above $1.25 for the first time since mid-July, breaking out of a little flag pattern with gusto ahead of the weekend.  It has jumped roughly 5.5 cents since hitting a three-year low near $1.1960 on September 3.  This dramatic rally has retraced (38.2%) of the decline since the year’s high set in mid-March a little above $1.33.  We are skeptical of the news that was used to fuel the end of the week rally.  We are cautious because sterling looks stretched technically.  It is almost half a cent above its upper Bollinger Band.  It has entered a key technical area ($1.2500-$1.2530) that includes past support and then resistance and a few retracement objectives.  The technical indicators are stretched, and the Slow Stochastics are hinting of crossing lower.

Canadian Dollar:  After falling almost 2% after the Bank of Canada defended its neutral stance a reasonably robust August employment report, the US dollar forged a base near CAD1.3140 early last week.  It then recovered sharply with three-quarters of the week’s 0.6% gain coming ahead of the weekend.ostensibly on the back of a report highlighting the indebtedness of Canadian households (debt-to-disposable income 177.1% from a peak of 178.3% in Q3 18).  Debt servicing (principal and interest) rose to a record of 14.93% in Q2.  Also, Prime Minister Trudeau’ formally began the campaign for next month’s election with a proposal to levy a tax on house ownership by foreign non-residents. The pre-weekend jump in the greenback took it to the (61.8%) retracement objective (~CAD1.3290) of the drop from the central bank’s meeting on September 3.   The 200-day moving average begins the new week near CAD1.3310 and a move above it would likely another run at CAD1.3355 area, which although frayed on intraday, it remained intact in August and early September.

Australian Dollar:  The Australian dollar tumbled against the US dollar for seven consecutive weeks into the end of August.  It advanced for the second consecutive week, rising in eight of the past 10 sessions.  It has poked through the resistance we highlighted near $0.6880 but has not managed to settle above it, and the Slow Stochastics reflects the loss of momentum. Still, the pre-weekend close was the highest since July 29.  A close below the five-day moving average (~$0.6865), which it has not done since September 2, maybe the first indication that some short-term players may be giving up.  The RBA minutes from the meeting at the start of September and the August employment report are the domestic highlights in the week ahead. 

Mexican Peso:  The JP Morgan Emerging Market Currency Index is up 2% so far this month, and the Mexican peso is up nearly 3.4% after depreciating about 4.6% in August.  The peso rose 0.65% last week, the second successive weekly gain after dropping for seven weeks through the end of August. It reached its best level month ahead of the weekend, and the dollar has surpassed the (61.8%) retracement objective (~MXN19.45) of its rally from the end of July.   The next immediate target is the (61.8%0 retracement of the year’s rally (~MXN19.32) and then the 200-day moving average (~MXN19.2950).  We see initial resistance in the MXN19.47-MXN19.50 area. 

Chinese Yuan:  The dollar fell for the second week in a row against the Chinese yuan.   Over these two weeks, it has lost about 1.1%.  Recall, the dollar peaked near CNY7.1850 on September 3.  It recorded a low of about CNY7.0675 on September 12.  Its markets were closed on September 13, but the dollar fell about 0.3% against the offshore yuan (CNH) then.  The yuan’s rise came alongside the budding optimism of another trade truce, and a heavier dollar, as we have seen, more broadly.  Given that the dollar has fallen below where the PBOC has steadily set the reference rate (~CNY7.0840), important signals may be given in the coming days of official desires.  We had initially thought that the CNY7.10 area would be the bottom end of a new range.  While there may be dollar demand around CNY7.05, a break below CNY7.0 would likely be seen as a greater gesture of goodwill that buying soy and pork given its domestic needs and the risks to the Brazilian soy crop.

Oil:  The price of WTI for November delivery reached its highest level (~$58.65) since the end of July on September 10 before reversing lower amid speculation that with US National Security Adviser Bolton leaving the Trump Administration, a deal that would get some Iranian and Venezuelan oil to the market was more likely.  We are skeptical are meaningful results, and the news has been used to reinforce the existing range.  Over the past two months, most of the price action has taken place between roughly $54 and $56 with a wider range of $53-$58.  The 200-day moving average begins the new week a little below $57.  However, the attack on Saudi Arabia’s key Abqaiq processing plant (processed half of the Saudi oil production in 2018) has reportedly crippled the facility.  It is this supply shock that will be the initial driver.  The IEA warned last week of a supply glut.   The attack changes the medium-term supply/demand considerations.  It is difficult to project with any confidence the initial spike in oil prices but we suspect a modest increase because of the extensive strategic reserves that can be tapped.  That said, the extent of the damage and the duration of the disruption is not clear.  Also, note that after posting early losses of more than 3%, the Saudi stock market (Tadawal) recovered to trade about 1% lower earlier today (Sept 15).  There are suspicions that government funds may have been deployed to support the market.  Brent can be marked up after closing last week near $60.20.  The 200-day moving average is $3 higher and the $65-area is important technically.  Nov WTI can move into the $58-$60.  Note that market-based inflation measures seem particularly sensitive to oil prices.  Higher oil prices exert upward pressure on headline measures of inflation if sustained.   Iran is the most likely source of the drone attack and geopolitical tensions may also lend gold support, which has fallen for three consecutive weeks for a cumulative $38 decline.  

US Rates:  The US 10-year yield has risen for eight consecutive sessions.  It finished August, with a five-week decline in tow and offering a yield a little below 1.50%.  It poked above 1.90% at the end of last week before closing just below.  As we sketched at the top, we suggest an over-determined explanation rather than a single driver, and in terms of market positioning, many trend followers and momentum players were leaning the wrong way.  There seems little to stand in the way of a test on 2.0%, though we suspect the move is excessive.  The December note futures contract fell every session last week and settled often settled on or near session lows.  It is beyond the lower Bollinger Band, which is set two standard deviations from the 20-day moving average.  In fact, it approached three standard deviations (~128-12) ahead of the weekend.  The MACDs and Slow Stochastics reflect the strong downward momentum.  

S&P 500:  The S&P 500 has continued to recover from last month’s decline in the face of the dramatic rise in yields.  It rose nearly 1% to extend is advance for the third week and closed above 3000 for the first time since late July.  The record high set on July 26 was near 3028, and last week, it approached 3021 before consolidating ahead of the weekend.  The MACDs have gone ballistic, but the Slow Stochastics are leveling off.  The S&P 500 has been holding a steep uptrend line since late August that starts the week near 2995.  A retest of the breakout near 2950 would be the initial target of correction.  So far this month, the S&P 500 is lagging behind the other major indices we track.  Its 2.75% gain this month trails Europe’s Dow Jones Stoxx 600, which is up 3.25%, and the MSCI Asia Pacific Index and its 4.4% gain.   


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