The key development in the capital markets last week was the dramatic equity market losses, and as we will discuss below, the strong recovery in the US markets ahead of the weekend, which is the kind of climactic price action that marks an extreme. Most major markets are off more than 10% from recent and often multi-year/record peaks. A little more than 10% of the S&P 500 components were off more than 20%. At the same time, the meltdown in equities did not fuel demand for the traditional safe haven--US Treasuries. The US two-year yield rose 9 bp and the 10-year yield rose 14 bp.
Fed officials were clear, the drop in stocks will not distract from the path of gradual normalization of US monetary policy. Some observers question whether what had been dubbed as the Greenspan put, then Bernanke, then Yellen, is still operative under Powell. Calling it a put is cute, but the real issue is that if there is a shock sufficiently to push the US economy off its course, the Federal Reserve, like any central bank, would take it into account when setting policy.
We share the assessment of Fed officials that the sell-off in US stocks has not yet reached a point that it would derail the economy, or jeopardize the Fed's mandates. With a high degree of confidence (71% chance by the CME calculation and nearly 87% by Bloomberg's assessment), the market anticipates a March Fed hike.
The US dollar rose against all the major currencies last week except the Japanese yen.
The yen and dollar's strength is consistent with our understanding that both currencies were used to fund the purchases of other assets, including equities. As equities, and other financial assets, were liquidated, the funding currencies had to be re-purchased. A key test awaits for this new found dollar strength if the equity markets stabilize after the recent shellacking.
The Dollar Index rose 1.4% last week, its second weekly advance. The momentum eased in the second half of the week as an important resistance (90.55-90.65 band) was approached. The technical tone is constructive, and the five-day moving average has crossed above the 20-day average for the first time since a few days before last Christmas. The next immediate target is seen in the 91.00-91.30 area.
The euro's seven-week rally ended with a 1.8% decline. The losses weakened the technical tone. Technical support in the $1.2220-$1.2230 area was frayed, though the downside momentum appeared to slow. The balance of power appears to have shifted and the euro needs to resurface above the $1.2300-$1.2330 area for the bulls to regain the whip hand. The five-day average broke below the 20-day average for the first time since last December 21. The technical indicators suggest the downside move may have legs, and the next target is in the $1.2135-$1.2150 area.
The dollar fell 1.7% against the yen last week. The unwinding of the funding position had greater impact than the elevated US yields. The dollar eased to new five-month lows ahead of the weekend but snapped quickly back as the equity market recovered. The price action reinforces the importance of support around JPY108. On the upside, the greenback needs to overcome the 20-day moving average which has helped keep the upticks in check here in February. It is found now near JPY109.75. That said, the dollar needs to move above JPY110.50 to bolster the dollar's medium-term technical outlook. While the technical indicators are supportive, they look fragile, though the recovery just before the weekend is surely constructive. The market did not react much to the Kyodo news report claiming that BOJ Governor Kuroda will be reappointed.
A hawkish hold by the Bank of England excited short-term market participant who bid sterling through $1.4050. However, the gains were short-lived and sterling finished near 1.5 cents below that intrasession high. Sterling made new lows for the week ahead of the weekend as the EU negotiator Barnier warned of the risk that there was no transition period. Separately, a meeting between the EU and UK negotiators that was scheduled before the weekend was canceled due to a schedule conflict for UK team. Sterling pushed through support seen near $1.3800, though closed back above it. The next level of support is not seen for another cent. The technical indicators favor additional sterling losses and the five and 20-day moving averages cross to the downside.
The US dollar rose about 1.3% against the Canadian dollar last week and this was sufficient to put it higher on the year. The US dollar spiked to CAD1.2685 ahead of the weekend in response to poor Canadian jobs data, which appeared to have been skewed by the hike in the minimum wage. However, the US dollar quickly surrendered the gains and a new session low was recorded near CAD1.2560. The greenback spent the rest of the session straddling the CAD1.26 level. At its highs, the US dollar met the 61.8% retracement objective (~CAD1.2665). The technical indicators are supportive for the US dollar.
The Australian dollar fell to $0.7760 before the weekend. That is a new low for the year and just shy of the 61.8% retracement objective of the rally from early December (~$0.7500) to the late January high (~$0.8135) that is found near $0.7745. The recovery in US equities appeared to help ensure the Australian dollar traded higher and managed to close firmly, a little above $0.7800. A note of caution is that the Aussie closed below the lower Bollinger Band for the third consecutive session ahead of the weekend. The technical indicators warn of additional losses, but if the Aussie can move above $0.7830, it would look more constructive.
Light sweet crude oil for March delivery fell for its sixth consecutive session before the weekend and finished below $60 a barrel for the first time since December 28. The second week of inventory builds in the US (first increase since the first half of last November) and a rising dollar and falling equities appeared to be the main culprits. The speculative market came into the week with record long gross and net long crude positions in the futures market. The daily technical indicators point to further losses, and the weekly technical indicators are just turning down. The next target is near $58, but there is potential toward $55. Still, the move has been dramatic and the pre-weekend close was the third consecutive close below the lower Bollinger Band, warning the market may have gone too far too fast.
Aside from the dramatic swing in yields on Tuesday (February 6), the US 10-year yield remained surprisingly firm in the wake of the dramatic decline in equities. New expenditures have been added on top of the tax cuts, which reduce revenue. This underscores supply concerns at the same time the Federal Reserve will buy $420 bln less than last year. Despite the recently reported rise in average hourly earnings, which spurred talk of inflation, the increase in nominal rates remains primarily a function of an increase in real rates. The 10-year breakeven fell seven basis points last week, while the 10-year nominal yield rose a single basis point. That said, the technical indicators of the March 10-year note futures suggest a bottom of some import is in place and the risk lies to the upside of price, suggesting yields will ease.
The S&P 500 lost nearly 5.2% last week after the sharp reversal ahead of the weekend, when it closed up 1.5% after being off 2.0% intraday. Previously, we suggested potential toward the 100-day moving average, which was about 2632 at the time. The market cut through it like a hot knife through butter. The 200-day moving average (~2539) was approached. Below there, the 2478 area corresponds to a 50% retracement of the rally since US 2016 election. The kind of recovery seen before the weekend, reversing from new lows to fresh session highs in late turnover is the first sign that the sell-off may have burnt itself out. The Russell 1000 Value Index fell 5.4% and the Russell 1000 Growth shed about fell about 4.9%. The former is off about 3.75% for the year, while the latter is off a little more than 0.5%