It’s Getting Very Interesting

One of the most difficult aspects of the current trading environment is trying to reconcile the relative impact of domestic economic fundamentals, corporate earnings and guidance, and government policy initiatives on price action.  In a previous post I posited that earnings were likely to capture investors’ focus for the next month or so rather than the macroeconomic data.  After the chaos surrounding Federal Reserve Chairman Ben Bernanke’s comments this morning, I think it’s clear to see that investors are perhaps more focused on the details of anticipated monetary policy than anything else.  Earnings, though still important (especially when you look at the 1.37% jump in the NASDAQ today), are simply on the back burner until the market finds out exactly what the Fed has in store.

With a fair bit of uncertainty still surrounding the Fed’s upcoming stimulus measures, the Treasury market saw its second consecutive day of significant selling.  Yields, once again, rose across the curve.  Ten year note yields climbed a whopping 8 basis points to 2.5886% while thirty year bond yields spiked nearly 9.5 basis points to 4.0065%.  This backup in rates is no doubt attributable to investor concerns over the prospects for smaller scale Treasury purchases by the Federal Reserve.  Since many had piled into the securities simply to get ahead of any Fed action, this morning’s commentary from the Fed chairman certainly provided the impetus for these investors to shed positions and take profits.  For my part, I still believe that Treasuries have at least one more rally left in them (mainly as a flight to quality asset if/when equity prices dip) and, therefore, view the current selloff as a relatively short term phenomenon.  That said, the prospects for inflation are growing.  Higher commodity prices (especially among agricultural commodities) and an expanding money supply are two key ingredients for stoking inflation.  This is likely another reason for the current selling pressure.  However, until we see any sort of growth in the money multiplier, the effects of these inflationary ingredients are likely to remain constrained.

After what can only be described as a wild week for the U.S. Dollar, the Dollar Index managed to finish the week largely unchanged at 76.99.  With this close, the index managed to hold its trend line support by the slimmest of margins while also putting in a doji star on the weekly Candlestick chart.  Both technical indications suggest, to me, that this may have been the washout week for the Dollar and that the trend is primed for reversal.  Furthermore, with all the negative chatter that surrounded the Dollar, there were plenty of reasons for the selloff to continue.  This proved not to be the case.

As you can seen in the chart below, RSI is indicating that the Dollar is currently in an oversold condition, thus raising the prospects for a near-term bounce.  The intermediate-term MACD, on the other hand, is still on a sell signal and is likely to remain so for some time since the moving averages that comprise it are firmly negative.  Taken together, this sets up for a basing scenario where the Dollar experiences a fairly sharp relief rally (up to about the 80 level on the Dollar Index), but fails to sustain the higher move for more than a week or two.  With the relief rally exhausted, a sideways to slightly lower environment will probably be seen as investors begin to grapple with the longer term prospects for the greenback in light of enacted Federal Reserve policy measures.  During this time, the moving averages will begin to reverse their negative trends and force the MACD into a more neutral/slightly bullish position, which would allow for another push higher.  Whether or not the price action plays out exactly in this manner is, of course, a guess on my part.  But as we’ve seen over the past couple of years, global investors have tended to shift their currency-specific concerns on a round robin-like basis, with the U.S. Dollar acting as the current focal point.  If the near-term bounce I’m anticipating does materialize, this would be a natural point in time for the focus to shift abroad (probably to the Euro).

 
Like the title of this post implies, things are getting very interesting in the marketplace.  Equity market volumes are beginning to pick up (5.2 billion shares traded on the S&P 500 today), volatility has been compressing, and inflation is once again being talked about with as much concern as deflation.  Certainly a stark change from only a few weeks ago.  And while the most bullish time of the year for the equity markets is looming, I can’t help but think that the risks of a sharp pullback are increasing by the day.  I know I’ve been a bit of a broken record in this view, but I think that if you truly take a step back and objectively look at everything that is going on right now, you’ll see an environment that is becoming more confusing rather than more transparent.  And with Federal Reserve policies mudding the view somewhat, it’s easy to view the current equity rally as a harbinger of better days in the near future.  But as today’s price action demonstrated so well, if you reduce or remove government’s hand from the financial markets anytime soon the strength of the rally fades fairly quickly.  Not the sort of environment that I would like to be caught holding a long position in.

Until Monday.....