A virus has spread across the markets as the
first half drew to a close. Many investors have become
giddy. The low vol environment was punctuated by ideas that peak in
monetary accommodation is past and that the gradual process of normalization is
beginning. Some investors may be exaggerating how soon the Bank of
England and the European Central Bank will raise interest rates, but there
seems to be little doubt about the direction of policy going
forward.
It is not just the ECB and BOE. The
Bank of Canada meets on July 12, and the
market is pricing in around a 75% chance of a hike. The Reserve Bank of
Australia and Sweden’s Riksbank meets in the week ahead, and they too will likely embrace the prospects of
normalization. Ironically, it is only the US, which has seen
core CPI and core PCE move lower for four consecutive months that the market
doubts. Using either the Fed funds futures or the OIS market, it
appears that less than a 50% chance of hike before the end of the year is discounted.
The BOJ is the other exception. It
has refrained from discussing an exit strategy. Its core inflation
rose 0.4% in May. The target is 2%. The core rate includes
energy. If energy is excluded as
well, prices in Japan are flat year-over-year, while overall household spending
contracted for 15-months year-over-year through
May. With the collective wisdom of the markets judging the Fed and
BOJ will lag behind the other central banks in the period ahead, the dollar and
yen were the poorest performing major currencies last week and for the month of
June.
The Dollar Index slumped 1.6% in the last week
of June. This offsets the minor gains
it had recorded earlier in the month. The 1..3% decline for the month is
the fourth consecutive losing month since the December 2010-April 2011
period. The 4.7% loss in Q2 is the largest since Q3 10. Although it
is below its lower Bollinger Band (95.73), the other technical indicators are
not over-extended, nor showing divergences. The next target is near
94.30. Below there, chart support ahead of last year’s low a little below
92.00 is sparse.
The euro broke out of the $1.11-$1.13 range,
which we suggested, points to a test on $1.15 and then last year’s high near
$1.1615. The 2015 high was recorded
near $1.1715. We note that the $1.1735 area also corresponds to a
38.2% retracement of the euro’s decline from May 2014 (~$1.40) to the low at the
start of the year (~$1.0340).
The dollar stalled against the yen after
approaching JPY113.00. A small shelf has been built around JPY111.80, which is also where the 200-day moving
average is found. Technical
indicators warn that the dollar’s upside may become more difficult.
The 100-day moving average (~JPY111.20) is an obvious target, below which lies
a band of support in the JPY110.40-JPY110.80.
The prospects of the BOE removing
accommodation, which it began with the raising the capital buffer, sent
sterling for seven consecutive sessions through June 20 before profit-taking was seen after sterling
approached the high for the year above $1.30. Technical
indicators are still supportive. The $1.3055 area represents the 38.2%
retracement of sterling fall from the referendum high of $1.50. If this
area is convincingly taken out, there is not much on the charts before $1.3400.
Of the various central banks that investors
are thinking are preparing to normalize policy, the Bank of Canada strikes us
as the most credible. The Bank of Canada has prepared the markets. The recovery of the Senior Loan
Officer survey after a couple of quarters of weakness seems to be the last key
piece to fall into place. On July 7, Canada reports its June jobs
data. Given the recent strength of the labor market, including rising
wages, it will take a significant downside shock to deter the rate
hike.
The technical indicators are getting
stretched, but there is no divergence at hand. As the US dollar has fallen
to new nine-month lows, it has built a head of steam. It fell every
session in the last week of June for more than a 2% decline and a nearly 4%
decline for the month. The next major support area is seen in the CAD1.2760 area. A
move above CAD1.3050 would be the first sign of consolidative/corrective
phase.
The Australian dollar culminated its recent
rally by poking through $0.7700 briefly before the weekend. It reached
its best level in three months. The Reserve Bank of
Australia meets in early July, and
although it is unlikely to change rates, it is likely to dampen lingering
ideas that a rate cut may still be delivered.
The central bank may not like the currency appreciation, but on a
trade-weighted basis, it is several percentage points lower than it was the
last time it was around $0.7700. Also with iron ore prices
rallying 20% over the past couple of weeks, the terms of trade have improved.
Initial support is seen in the
$0.7620-$0.7640 area.
The taper tantrum sparked in Europe managed to
do for US yields what economic data and the Federal Reserve were unable to
do–steepen the yield curve. The two-year yield rose three basis
points in the last week of June, while the 10-year yield rose 17 bp. The
backing up of the long-end was the most in a week since the first week in
March. The yield has entered the 2.30%-2.35% band that may take some time to work through the supply. The September
note futures peaked on June 14 and spent the second half of the month moving
lower, effectively unwinding what it had gained in the first couple of weeks of June.
The 125-08-125-15 area houses retracement objectives and other chart
points. Bearish divergences in the technical indicators and the
extreme market positioning provides scope for additional declines in prices
(higher yields).
Oil prices rose every day last week, extending
its advance to seven consecutive sessions, the longest such streak since
last September-October. The rally has approached the 38.2%
retracement of the sharp decline (~$46 basis the August futures
contract). The technical tone looks constructive and there is near-term potential into the $47-$48 band.
Support now is seen near $44.50.
Although the S&P 500 had a difficult week,
having to cope with the rise in yields and the failure of the Senate to pass
healthcare reform, which raises questions about the broader economic agenda, it
managed to close higher on the
month. It is the seventh monthly gain over the past eight months.
It is the seventh consecutive quarterly advance. In fact,
since the beginning of 2013, there have only been two quarterly declines in the
S&P 500 (Q2-Q3 15). Many investors still seem inclined to
buy pullbacks. A break of 2400, though, would be a test of this sentiment. Over the past week,
the Russell 1000 Growth Index (RLG) fell 1.5%, while the Russell 1000 Value
Index (RLV) rose 0.35%. On the month, RLG fell 0.4%, snapping a
seven-month advance, while the RLV rose 1.5%, breaking a three-month down
draft.