Here we go again

Risk assets plunged today, with Nikkei futures seeing a 250 point drop Thursday overnight, as the Yen was bid heavily across all pairs, with funds flocked to safe haven and carry trades reversing course. Several commodity FX yen crosses are on the precipice of head and shoulders breakdowns, after selling off heavily back to their necklines. Today’s biggest mover in FX was CAD/JPY in fact, which is very deflationary. Commodities in general are losing their fundamental bid. Intermarket corrs are at 1987 crash highs, eliminating the diversification premium investors offer for commodities. And global growth slowdowns, austerity, and deflationary threats in Eurozone, USA, & Japan are bearish for commodities, the nations that export them, and risk in general.

Speaking of commodities, the Aussie Dollar suffered big selling as well, both against JPY & USD. The skyrocketed nominal housing prices and very hawkish rate policy since crash lows could turn out to be more bearish than bullish if exports to China slow, as Chinese economic data and the one-time nature of its stimulus package suggest. With the Baltic Dry Index posting record consecutive losses, global trade probably will not be a “way out” of bearish developments in the forthcoming months.

On a technical basis, the AUD/USD seems to have double-topped at its June highs and was unable to break up to or back above its 200DMA (which price has had very high confluence to), leading to its current bear flag formation. As my technical analysis and FX Concept’s Jonathan Clark’s views suggest in the charts below, it appears to be a great short. The AUD/JPY does as well, as it found selling at its 55DMA and appears primed for a move down to 72.50 and 70.00 support levels, the latter of which corresponds to April 2009 levels.




And with the Aussie Dollar, so goes copper, as it is primed for a breakdown through the 2.60-2.70 zone, after finding selling at its 55DMA.


Even gold has bearish chart developments, breaking down through its 55DMA and subsequently forming a bear flag. The long gold/short euro trade on sovereign debt crisis was a popular and crowded position many traders took during the euro’s plunge but with the recent diminished-interbank-funding-fueled euro rally, many of these positions will most likely be facing liquidation and unwinding. The chart below exemplifies the recent inverse relationship between gold and euro (historically not the case) with DZZ (inverse gold ETF) and EUR/USD spot.


With AUD, CAD, copper, oil, and gold selling off big and showing very bearish chart developments on intermediate and long term time frames, the markets currently imply very deflationary developments.

The biggest news in JPY space, however, was the USD/JPY breakdown below 87 support. The cross experienced a breakdown last November through that level but it reversed course very quickly. The last time the dollar fell below that level for a material amount of time was 1995, which subsequently led to the BOJ instituting ZIRP. Fifteen years later, Japan hasn’t changed policy and nominal rates cannot fall any further. BOJ intervention is becoming increasingly likely. This time around, however, the sovereign sector is levered up and further monetary easing may lead to secular shifts in perception and eventually result in a JGB crisis (previously out of the question due to the private/financial sectors being the ones with bad debts, which inherently causes a rush to safety of its yet-to-be-levered up government’s bonds).

Equity space also found big selling today, with the S&P down 2.88%, after finding huge resistance at its 55DMA (starting to sound familiar?). The head and shoulders (neckline 1015) remains in play and deteriorating price and expanding volume to the downside suggest this down move will be sustained for some time. The head and shoulders target is around 815, near February 2009 lows/support. A chart of the SPY ETF proxy is posted below, to show volume as well as price action.


And with the 12 month moving average breaking down (and subsequently retracing and resuming selling), this wave down is implied to be a longer-term selloff rather than a correction.


The technical confluence in all of the charts of risk assets is an alarming development. With so many assets (in all classes) sitting on head and shoulders support levels after selling off from 55 and 200DMAs on heavy and expanding volume, the downside risk to risk assets is very high and a strong move down appears the most likely scenario.

This also coincides with the safe havens finding strong bids, namely USD, JPY, & Tsys. 10Yr yields are back below 300bps (as we were expecting in previous posts) and still implying much further price declines in equity, a correlation we have been tracking for weeks.


Everything is moving in tandem, which is indicated in inter- and intra-market correlations at or near all-time highs. Meanwhile, the JCJ Implied Correlation Index closed today just under 75, implying crash risk is elevated.’


The selling in risk implies a rush to cash globally, with the currencies with largest debt outstanding finding the largest bids ahead of deleveraging. Interbank funding costs have also dramatically risen, especially in Europe, where the Euribor-EUR Libor spread is spiking, indicating a larger portion of marginal interbank lending is occurring at the higher end of reported rates. Again, very deflationary developments.

And market internals aren’t any better, with breadth very negative and volume expanding greatly as markets selloff. The 20DMA on SPY volume is currently about 40% higher than just last March, in the middle of the exhaustion phase of the massive rally. In addition, July 6 saw the first “Hindenburg Omen” issued since July 2008, two months before the stock market crash. There were also Hindenburg Omens issued in June 2007, four months before the all-time top in American equity markets. Historically, these occurrences resulted in a 5%+ move to the downside 77% of the time and have preceded every major market crash. We don’t expect another crash of fall 2008 proportions, but we do expect a strong move down in risk markets, possibly in all-out panics in certain assets, such as certain commodity currencies vs JPY & USD and specific Euro nation bonds (specifically CEE and Spain).

Economic data is supporting what the markets are beginning to price in as they reverse and sell of, on big volume. The ECRI LEI came in today at -9.8, which historically has always preceded a recession. Consumer confidence at 66.5 vs 74.5 consensus vs 76.0 prior. And the below-consensus China GDP numbers have been adding downside pressure as well. It appears that global growth recovery has peaked and as peak stimulus is spent and a global push for austerity is underway, deflationary forces are beginning to be priced back into the market.

And Hungary’s breakdown of talks with IMF & EU signify two things: 1. without austerity (and consequently significant economic deterioration), nations (esp CEE) will not qualify for IMF funding; 2. the Hungary situation will bring back the theme of European sov debt crisis, which should shift the EUR trend back down as interbank funding loses thematic importance to sovereign funding; and 3. go long USD/HUF and CHF/HUF and stay long.

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