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Friday Paper Round
June 23, 2023
First of welcome to all new subscribers. I very much appreciate you following me on this journey. There is much more to come. This content is intended for any level. We’re mixing heavy stuff with educational and fun content.
I have been pondering about our good friends on the central banking wheels and concluded with the following observations:
The immediate mechanics of traditional monetary policy are all working perfectly. Raise the policy rate, short-end-market rates rise, bank funding becomes more expensive, credit conditions tighten, rates offered to the economy rise, and credit becomes harder to come by.
But economies aren’t slowing as much as expected; job growth isn’t slowing anywhere near as much as expected; labour market demand is far higher than expected; as a consequence, workers feel emboldened to demand higher wages – and companies are paying them. The wage/price spiral is now live.
Core inflation is remaining much stronger and persistent.
Despite all the policy tightening, the major central banks see inflation more than double their targets at the end of this year – critical given that all the benefits of base effects will have been used up; that inflation will still be beyond target at the end of the two or three-year policy horizon; that economic growth will be stronger than expected (despite policy settings).
Given current inflation and the inflation outlook, one might have expected the central banks to be explicitly more hawkish. But the FOMC, in spite of the dots, did hold; the ECB is only nodding towards a July hike, but not clearly pushing for more; the BoE keeps saying it only might need to hike more.
They all have the same problem – each central bank has reached a critical policy point. Tighten further and they turn the corner from soft landing to almost inevitable hard landing. The Eurozone is not designed for a depo rate of 4% or higher; the UK certainly isn’t designed for a Bank Rate of 6%. The central banks are pausing or easing off because they know what comes next. There’s no alternative. The only way to break the wage/price spiral is to break the economy and force job losses. Only when demand for labour has evaporated and workers are just happy to have a job, will that cycle end.
Given that we are at crossroads it is fascinating to see maximum risk bullishness on many fronts. The narrative here will have to change and the moment of truth has to come when central bankers face the tough choice of taking on the inflation fight further, or, as many anticipate just roll over and point towards higher recession probability and lower inflation paths ahead.
Either way, I am pretty certain that this opens a new market narrative which will induce higher volatility and new trading opportunities. Fingers crossed.
For now, let’s focus on what the model and charts are telling us. General observation would be some rollover signals on risk assets and corresponding FX pairs. It could just be a consolidation but some of the commodities are under pressure which could be liquidity and/or growth induced. The model’s signals certainly are trying to build a story here, more so than in previous weeks.
Let’s look at the individual signals in more detail.
ES, as indicated in a tweet earlier this week we had a nice little reversal which the model so handily highlighted. Now these signals just highlight the timing but never the extent of the reversal and usually this does not negate the trend which is still a buy according to the model.
NQ, ironically did not get a reversal signal. The model is still long for now. The discussion of whether it’s a bull or bear does not impact the model luckily. It’s frankly irrelevant.
RT (Russell), has also seen some reversal which was nicely flagged, undoing roughly half of the recent upswing.
FTSE (UK), the model had initiated another short a week ago, which seems to have been the right call.
DAX, is playing with fire below the 50-day moving average. The model is still long but this could take the model to switch to a short soon. Keep an eye on it.
Nikkei, got finally some pullback from the recent upswing. Now stopping at the 20-day line while the model still holds a long.
HSI (Hang-Seng), chop-fest. After seeing a buy signal the model has quickly switched to a short now.
ZT (2-year US bond), is back to the March lows. The model is short and initiated another short just a few days ago. Will we break the previous lows?
ZN (US 10s), meanwhile, is now forming a small base it seems. The model is still short, however.
UB (30-year US), is certainly showing signs of life here. The model is still short and we are knocking on the 50-day line which should prove as resistance.
Gilts (UK 10y), as mentioned in yesterday’s tweet, the model closed out the short it held from April. The UK’s troubled are well documented and with the BoE now panic hiking, this could indeed be a short-term bottom for this future for now.
JGB’s (JP 10-year yield), even though I don’t like doing TA on yields (I can’t find the JGB future on TW), it is noteworthy that bonds have rallied and that yields are now back to the 200-day moving average. The model is long bonds (shown as short on yields).
US 2-10s curve is closing in on the March lows. The model caught this one nicely back in May and rode down a 50 bps flattening.
Germany 2-10s, curve has broken into new lows and the model is still pointing to a further flattening.
UK 2-10s curve, vicious move post-50-bps hike surprise. As also stated in a tweet during the week, this can get to a -100 bps level similar to the US.
SOFR Dec-24, the model is short but it would seem we are forming a base. I will go into detail on this in a different post. Also, it is a bit dirty to show this historically without a roll as a fixed future date future (Dec-24) obviously rolls down in time so historical contexts are skewed.
GBPUSD, reversal signals are flashing while the model still holds a long.
EUR/USD, nice little back-test onto the 20 / 50-day lines. The model is still long.
USD/JPY, the model is still long but we had now again an overbought signal flashing for reversal.
AUD/JPY, is showing also strong reversal patterns after the recent surge.
Gold, the model triggered another short. We are not that far from the 200-day average around 1900.
Silver, looking ugly. While the model is short there is an oversold signal flashing.
Copper, the model is still short although we are now testing the 20 / 50-day lines.
Platinum, is quite a vicious sell-off, closing in on the YTD lows.
BTC/USD, the elevator up back to 30k was fast and fooled the model into flipping into a long from short.
Signal Weekly Portfolio Performance
Looking at the weekly performance of the model’s signals (Thursday close) would indicate a good past week. None of the signals has changed but some are in reversal. Will be interesting to see whether this impacts the model during the coming week.
I have to admit that I didn’t really care for Daft Punk’s music until their R.A.M (Random Access Memories) album. It was a revelation. Especially below song blew my mind as to how they managed to sculpt music around the spoken words of an interview they did with legendary Giorgio Moroder (the daddy of techno music).
I spent many hours hooking people onto this track, it got a bit crazy when everyone started reciting those lyrics word for word. They are still stuck with me. Therefore, listen in moderation.
“Once you free your mind about a concept of
Harmony and of music being correct
You can do whatever you want
So nobody told me what to do
And there was no preconception of what to do”