For the past couple of weeks I have been a little cautious, expecting to see a pullback in risk appetite and for the past couple of weeks I have been proven wrong. Last week I noted the danger of entrenching myself in a bearish outlook. The uptrend in stocks is strong, and the rising bond yields appear to be a result of confidence in the recovery rather than loss of confidence in US credit worthiness. While we can't predict the future, we can try to make the best decisions based on the information we have (I think that's a line from Wedding Crashers). So, here's what we know:
Fed will continue to normalize - the Fed has ended its $1.25 trillion mortgage backed securities (MBS) program. A recent
Bloomberg article suggested that industry buyers such as banks and pension funds stand ready to step into the MBS market and will be able to fill in the void left by the Fed. In such a scenario, mortgage rates increases may be negligible.
The Fed is also widely expected to raise the discount-rate tomorrow (Mon, April 5th). This will be the second increase this year. The first hike on Feb 18 (+0.25% to 0.75%) was had a muted impact on the stock market but boosted the USD.
The FOMC will release its meeting minutes this coming Tuesday at which point we will have a better idea on how the latest job figures and rising bond yields affected the Fed's outlook.
Economy continues to improve - Non-farm payroll, ISM manufacturing index, Case/Shiller index, declining 10yr notes, and improving prices of mortgage backed bonds, in particular the infamous 2006 vintage (see
ABX.HE.AAA.06-2 chart below), all point to the continuation of positive momentum. These incremental improvements supply the Fed with the ammunition it needs to continue and implement its exit strategy.
Inflation is still in check - PPI and CPI figures for March tempered some of the expectations out there for impending inflation. One has to keep in mind that while the Fed did "print" vast amounts of money during the crisis, equally vast (and probably greater) amounts of dollars were literally evaporated from the world economy. Thus, the supply of money is likely still contracted compared to what it was pre-2007.
Now that we've covered some of the information available to us, let's try to frame our bias for the week.
US Dollar - conditions are still favorable for the US dollar. As noted above, improving economic conditions will guide the Fed further down its exit path which is bullish for the dollar, especially since the BoE, ECB, and BoJ are still sounding dovish. Technically, the USD index (DXY) is cruising confidently within an upward channel (see image below). In fact, as of Sunday night, the DXY is seen bouncing off its lower channel line. I will stay bullish on the USD as long as it stays above 80.50 and does not breach its 50 MA (black line in the chart below)
Euro - The "anti-dollar" experienced a moderate relief advancing against the greenback for most of the week. Interestingly enough, Greek/German spread also rose at the same time, suggesting the euro's gains were mostly related to short covering rather than any fundamental improvements. As I write this, the euro is pushing against a weekly trend line. If it manages to break the trend, we may see it advance to 1.3660 or as far as 1.3800. But the bearish sentiment (as evident by the COT reports) suggest that euro rallies will be met with renewed selling pressure.
GBP - the British pound performed better against the USD than the euro. UK manufacturing data and a somewhat clearer political outlook pushed the pound higher against the dollar and euro. We can expect sustained strength against the euro but not necessarily against the dollar. The GBP/USD failed to break above the 1.5360 level. Until this resistance is taken out, we will remain negative on GBPUSD.
Japanese Yen - perhaps the most attractive opportunities this week/month will be shorting JPY pairs. As I noted several times in the past couple of weeks, JPY was expected to weaken as of the end of March. The COT report exposes a major shift in sentiment from net-long to net-short positions for Non-Commercials. The bet is on and its against the Yen. CADJPY has been one of the best performing pairs and we should expect to see it rally further.
Commodity Currencies - I still prefer the loonie over the aussie. The differential will be more pronounced if we experience a breakout in oil prices above $85/barrel.
S&P 500 - as for the S&P, the road up seems clear but the closer we get to 1200, the more likely we are to experience a meaningful correction. By this point, we can assume that all the good news is already baked into the cake, so cheerful economic data may not suffice to lift the stock market higher.
I will try to post updates tomorrow after the ISM and Home sales figures (10am EST) and another one after the FOMC release on Tuesday to adjust my views. In addition, I plan to add a new section to the site, something like "chart of the day" where I will try to identify specific trading opportunities based on some simple rules.
