Shift in Focus
The pre-market futures are under pressure this morning and looking to test the recent support levels. Friday generated concerns that all of the sudden the Fed would change course and start raising rates on a strong labor report and that was followed up by the expected European QE. But is that what is driving the market this morning?
Shifting Focus to DEFLATION Concerns
To make sense of it all, we must first put everything in a chain of events and their impact. During the start of the credit crisis we saw a spiking rise in the dollar; this was simply a flight to quality. Investors rushed into the dollar as it is traditionally considered the “safe haven”. When the Fed started their QE program it help reduced the dollar value and we saw it quickly fall again. When QE ended there was intimal concern that the Fed would raise rates and the dollar rallied again, but then came another version of QE to devalue the dollar.
QE and the Dollar
In the beginning it was the US that was playing the QE game and eventually after a couple of years of dollar volatility it brought some equilibrium to the currency market. The US, while a “safe heaven” was also devaluing their currency to help boost the economy and reduce the trade deficit. From late 2011 to mid-2014 we had a rather calm dollar currency market, but then things changed.
As I mentioned in the Market Preview it was Japan that fired the first big salvo against the dollar by launching their radical QE measures. While it certainly impacted the Yen/Dollar trade by more than 20% in short period, it was countered fairly effectively by the largest QE yet by the U.S., QE3. This kept the dollar futures from breaching the 84 resistance level. This was a war between Japan and the US. As long as the US could keep a stable dollar in the broad index, the volatility in the dollar/yen trade was a headache but not a global game changer. We could ride out an assault from a Japanese QE salvo – painful, but survivable. The Japanese massive QE attack quickly vanished from the financial headlines.
End of QE3 – it really wasn’t until the end of QE3 that we started to see the currency war start to unravel. While the Fed was putting a marketing effort together to end the QE3 program the dollar was poised to start rally. There was a broader assumption that interest rates would soon rise as the program was winding down. At first it was a slow-wind down of printing new money that started at the beginning of 2014. Each meeting they cut the printing of new money to buy assets. It is important to note at this point that the ONLY part of QE that was winding down was the printing of new money to expand the balance sheet, the rest of the QE measures would remain firmly intact (buying bonds, buying mortgages, and zero interest rates). The Fed had acquired enough short-term maturity paper that was maturing to rebuy more bonds that printing more money wasn’t necessary; they had added a few trillion of assets to their balance sheet. It is also important to note that the QE money printing to buy assets is NOT a measure of function of the money supply ironically, which continues to expand (M1 series).
QE3 “officially ended” (in name only) in October of 2014. At this time the dollar index was again pushing up against the 84 resistance level that it hadn’t breached since early 2010 at the end of QE1. Since then the series of QEs has kept the dollar from breaching that level. In August of 2014 rumors had started that ECB president (Yellen’s counter-part) would announce their own version of QE. By November of 2014 it was confirmed and QE Europe would start in the first quarter of 2015.
The combination of Japan and soon Europe’s QE policies, with the ending of the US QE3 program (in name only) was the spark catalyst that sent the dollar breaking through the 84 future index level on a very strong and precipitous rally.
By the end of 2014 the dollar had breached the 88 resistance crisis levels from 2009 and was to remain on a tear higher.
Friday was the amazing Labor Report, which sent ripples of concern that the Fed would certainly raise rates now – as if their only charter was unemployment and job creation, but that is only ONE of their mandates – the other is price stability (modest inflation).
Monday brought forth the expected start of QE, which only furthered the dollar rally.
Yellen and other Fed members had voiced concern back in November when they saw the dollar starting the rally. While they didn’t speak the dreaded word “DEFLATION”, they did mention “disinflation” and concern about GDP growth, trade, and broader impacts to US domestic economic growth. In the December FOMC press conference Yellen assured the audience that rates would NOT be raised for the next two meetings (that would mean no rate hikes in January or March meetings). However that did not stop the dollar from rallying.
After the New Year, they started being more aggressive in trying to “talk down” the dollar rally. A few more dovish Fed members said that we should wait on raising rates. They tried to lay the perception that the Fed would remain accommodative, but it still didn’t help. The world saw the US end QE, economic headline data (Jobs, Unemployment, and GDP) all look robust and great, which only fed the belief that rate hikes are coming.
In Februarys Yellen testified before the Congress (Humphry Hawkins) and further tried to talk down the dollar. She again stated she would not be raising rates in the next few meetings and it was more data dependent. The market rallied, but it did not stop the dollar rally.
The Fed has managed to keep a lid on bond yields from moving higher and has helped continued to fuel the market rally. What they have failed to do is halt or even slow the rapid dollar rally and that brings their greatest fear ever more closely in which talk of “disinflation” turn to “deflation”.
Shift in Focus
However, perhaps there is a silver lining in the strong dollar rally for Yellen and her Keynesian governors. It is justification, despite the strong job numbers and lowering U3 unemployment rate, to keep rates at zero and remain accommodative. She can now shift focus from jobs and unemployment, which they can wave the victory flag saying they have accomplished ONE of their dual mandates, but now shift focus to INFLATION and “price stability”.
Courtesy of FRED
The Fed has targeted 2 to 2.5% CPI inflation rate, but right now the CPI is declining “disinflation”, which is the exact opposite of what the Fed is trying to accomplish. To get inflation to ramp you need to keep rates low or take them lower, you also need to print MORE money.
Perhaps next week’s FOMC meeting will be the start of this focus shift, we just had a beyond stellar Labor Report (headlines). The Fed can announce “mission accomplish” when it comes to jobs and unemployment. Now they must focus on the “disinflation” pressure that if left unchecked can turn quickly into “DEFLATION”.
All this means is that low interest rates and accommodation are here to stay.
Europe and Japan QE, coupled with the “official end” of our own QE3 is what is driving the dollar higher. What is currently sending sell pressure into the equity and bond markets is the assumption that the Fed is about to raise rates, which ironically also further fuels the dollar rally.
The market doesn’t know what to make of all this. Will borrow rates go up making margin less attractive? Are bond prices to high and yields to low? The market is under pressure, the bond market is in flux, yields seem to want to rally but are hesitant, and all the while the dollar continues to rally. The market needs some focus and certainty from the Fed and this next FOMC meeting could be just the time to start laying the ground work for a shift of focus to justify continue zero rates and accommodation.
Support & Resistance
We again are testing that 17,800 level and we could crack and move lower – but there is nothing new today that would warrant panic selling.
We could see some strength heading into the close, but right now we are under pressure. Look at 4400 as a strong close, with 4350 as the lower bound support. I don’t think the iWatch is going to be a game changer that keeps this market from declining.
SPX 2060 – 2080
This remains the slop range and consolidation until we hear from the FED at the next FOMC (next week). In a short-term panic we could see a pull back to 2040. VIX moving up into the mid to higher teens, which is cautiously pricing in volatility correctly.
The pre-market futures look like we will crack the 1220 range and head to 1200 before we see support. I would watch the 1200 area carefully for support as this is the tell-tale indicator for broad-based order flow.
No Rate Hike!
Again the market is moving in fits and starts not because of earnings or market fundamentals, but rather monetary policy of the Western Central Banks.
Will the Fed raise rates? I don’t think so – even the hint of them raising rates is sending this market lower and the dollar spiking higher. Imagine if they said we are about to raise rates? Where do you think the dollar, bonds, and the market go? It would turn ugly fast.
Not to mention these are born-again Keynesians – they haven’t even begun to inflate yet and that is their mantra.
I suspect we will see a shift in focus from job creation and unemployment, to the concerns about the dollar and disinflation/deflation. Finger pointing to Japan and Europe will soon follow and we will be told they are the cause of our demise – justification for remaining uber dovish to the joy of all.