Weekly Outlook WC 01/05/2023

This week’s piece contains a tin foil hat, a nothing burger and the chance of a shock that isn’t priced in.

But as always, what should happen and what could happen doesn’t mean they will happen. These are just my thoughts to get me thinking about all of the moving pieces and try and build my understanding in order to prepare for the week ahead and support my techincal analysis.

Last week’s recap: 

One of the most anticipated events turned out to be a huge anti-climax. The potential of a new era starting soon slowly fizzled away. A full blown ‘nothing burger’.
This was the BoJ policy meeting being led by Ueda for the first time. There was expectation of hints toward changes or even a scrapping of one or both of the super easy policies or practices – the YCC and the ultra low rates.
The announcement could be boiled down to ‘no change, but we are conducting a review which will take time’.

Thinking about it . . . Is Ueda hawkish but buying time?

***Story time, grab yourself a tin foil hat*** 

Why is this a possibility? The amount of bonds that the BoJ hold as a part of the YCC is LARGE. I’m not saying that the BoJ hasn’t managed their risk a la SVB – but maybe a hawkish pivot could completely crash the BoJ books and cause issues. Is Ueda buying time to offload bonds before there is a hawkish pivot?

*** end of tin foil hat time***

Inflation in Japan is beginning to rise and with the impact of the recent Shunto still to fully filter into the economy, this is likely what the BoJ want – prolonged period of inflation – any move to scrap their current stance could kill the inflationary pressures.

Elsewhere – the US saw GDP drop but unemployment also dropped. The cost of labour slightly rose – meaning wages are remaining strong.
Below is a chart which shows US Employment Cost (bars), Core CPI (Purple line), recessions (red vertical zones) and the range of US employment costs over the past 12 months projected backwards.
I have not included the coved recession as that is a standalone event.

USEMCI 2023 04 30 08 52 44

The recession not shown (due to data availability on Tradingview) in 1980 was triggered by rocketing inflation on the back of accommodative monetary policy (like we’ve had with COVID) and coupled with the Iranian Revolution which caused a shock in oil prices.

This 1980 recession technically ended in July 1980. But the recovery was short lived.
Double Dip recession 1981-1982 – Inflation was still very and rates had to rise massively (up to 19%).
Gulf War Recession 1990 – 1991: Triggered by oil price rises on the back of already rising rates. The Fed had hiked to 9.75% in the year before the recession.
Dot Com Recession Mar 2001 – Nov 2001: Fed reached their peak rate rate for this hiking cycle a year before the recession at 6.5%
GFC Recession Dec 2007 – Jun 2009: Banking crisis, house price crash, oil price spiked in the middle of the recession.

3 out of the 4 (if you class the 80s as one event) had the traits we are seeing now. Oil price shocks, peak fed hiking cycle, high inflation. The 80’s is very interesting as one of the triggers was stimulus aimed at increasing unemployment in the late 70s. By trying to combat unemployment the Fed pumped money into the system.

If we look at what is happening now, it seems to be a perfect storm. Stimulus pumped into the system to recover from COVID19, Oil/commodity shocks via supply chains and Russian war, runaway inflation. Each time the cost of unemployment has been at or above 1.15%, we have seen a recession. However, the odd thing here is initial unemployment claims. In the examples where cost of employment has peaked at over 1.15%,  the initial unemployment claims have risen sharply within around 6months. So there is definitely a counter argument to be made.

Core PCI was also released last week. The figure of 0.3% MoM translates into an annual rate of 3.66% (compounded), which is down from the peak of 0.6 (7.2%yearly) in Sept and Feb. Going back a few weeks, the CPI headline figure came in at 0.1% MoM. The yearly figure is likely still being bumped up by spikes seen several months ago which will begin to drop off – so could this potentially be a trigger for the Fed to pause sooner – and could they be in the sweetspot of not completely breaking the labour market whilst bringing measures of inflation down? This outcome would definitely be a shock as the market is expecting another hike.

Australian CPI continued to remain relatively stable MoM, but dropping on the YoY. This gives support to the RBA that the pause was likely the right thing to do. The next print should see what impact the latest hike is having, if inflation ticks up MoM then they may decide to tighten the screw another little turn to nudge it in the right direction.

German CPI is back down in the historical band, albeit close to the top of the band at 0.4% MoM; but Spanish and French still higher than they were during all of the 2010’s, it lines up with the ECB hiking narrative.

The Week Ahead:

A few big announcements.

AUD Rate announcement is first up – expected to remain as they are. Nothing has really suggested a change in course is required. It’s likely that this will be a “see what the upcoming data looks like and we reserve the right to change rate as appropriate”.

US Announcements: There are some important releases that build up to the biggie and all could influence the decision.
Monday: ISM Manufacturing PMI
Tuesday: JOLT Openings
Wednesday: ADP Non-Farm Payroll
Wednesday Afternoon: ISM Services
Wednesday Evening: Fed Rates and FOMC Presser

PMIs are already pushing recessionary levels – it will be interesting to see what the price component of the manufacturing and the services will be as this will be a sign of inflation levels.

USBCOI 2023 04 30 10 08 36
JOLTS are still high going into this print with non-farm, private and manufacturing still well above any recessionary levels. There was a decrease of over 1m last time out, so it could very well drop.
Finally, on the morning of the Fed announcement, the ADP Non-Farm employment change figures will be released. Both this and the JOLTS form a part of the Fed dual mandate, alongside price stability.

USEC 2023 04 30 10 18 09

What this could mean for the big rate announcement. The consensus is that the fed will hike again. The banking stress didn’t really materialised and nothing has visibly collapsed yet. 25bps hike is expected with the FedWatch

Screenshot 2023 04 30 103932

The pricing reflects a 83.9% probability of a 25bps increase. But if you look at a month ago, the was a near as makes no difference 50/50 split. What has really changed in 4 weeks? The banking crisis hasn’t materialised but are we still seeing pressures which would lead you to think more hikes are required? Everything seems to be heading down for the Feds stability portion of the mandate, and employment is cooling slightly. Possibly there is a concern around wages.

Something I will be watching out for are signs that the Fed could pause which isn’t really expected or priced in:

The PMIs to drop – manufacturing is already pretty low, and lower than services. If services drop to or below 50, this could be a signal.
JOLTs and ADP to show a significant decrease – this impacts the Feds employment mandate, there is a bit of wiggle room for them to be comfortable, but if these figures are already heading lower in a meaningful way why would the Fed hike more?
Either Way – the FOMC announcements and presser will really set the tone for the the rest of the data for the next few weeks. It’ll give a bit of context around what to look out for.

ECB’s rate announcement is Thursday. The ECB are usually behind the Fed by 6months-ish. I think it’s nailed on that another rate increase is coming, but 25 or 50 is the question. There are a few PMIs on Tuesday – looking at the price component will be important.

Overall: I’m expecting quite a bit of chop this week and there is a significant chance of SLs being clipped as both simultaneously holds off trading until FOMC but also gets a bit twitchy and wants to be positioned.

I personally think the upside for the Fed is limited. – 25bps isn’t anything to write home about and it’s already priced in, 50bps is very very unlikely and unless Powell comes out with a gauntlet on his arm carrying a Hawk throwing around the need for more increases going forward, the market could take this as the peak and sell off.

Supporting factors:

DXY: Sitting at the 101 support and beneath a cluster of EMAs. a break below this may open the door to drop below 100 and down to 99 where the weekly 200 meets resistance.

DXY 2023 04 30 10 59 23

EXY: Pushing up against the weekly 200EMA. Above that is a resistance level at 111.50 area. A break above would possibly open up the door for 115.

EXY 2023 04 30 11 01 37

SPX rejected the Daily 55 and 200EMAs as well as the weekly 55EMA and is trading comfortably above the Weekly 200EMA. Currently at a resistance level, a break above this has a bit of fresh air up to 4300.

SPX 2023 04 30 11 04 07

OIL: Stuck in this narrow range. The OPEC gap has been filled in. It’s just jammed in this channel. A break below the weekly 200ema @ $74 and a break above the Weekly 55 and daily 200 at $84 may be significant for short term direction

OIL CRUDE 2023 04 30 11 06 55

Iron Ore: There has been a significant fall last week, clean through the EMA cluster. There is no technical reason for it to stop until the support at 93.

TIO1 2023 04 30 11 11 05

SZSE1000: The China rebound isn’t as strong. The SZSE1000 has dropped below all the EMAs, there is a recent low around the 5200 level, but the next big support is around the 5000 level.

399011 2023 04 30 11 18 48

Gold: Still in touching distance of it’s ATHs. A pullback to the 1900 level and somewhere towards the lower end of the green box, with a couple of EMAs coming up to the 78.6% fib level and minor price level could be a nice support level.

GOLD 2023 04 30 11 23 10

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For a summary: 

I think the potential of a Fed pause is underestimated- inflation is dropping and the US may be in a sweetspot of inflation coming down while jobs haven’t completely tanked so I’ll be watching the releases closely in the run up to the meeting. Trying to pre-empt the market ahead of a major announcement is a recipe for disaster, but planning and preparing for the outcome based on known factors and supporting evidence certainly isn’t.

A China rebound hasn’t happened. As a result of China not picking up, the AUD has potentially suffered – with the AUD decision coming up I’m expecting a no change decision. The demand for commodities to fuel the growth isn’t there. If the demand for oil isn’t there and we are at a price level where OPEC decided to cut production – there is the possibility of this happening again – especially with OPEC/US relations not being the warmest. Could this potentially support the CAD?

EUR – it’s a coin toss between 25 and 50bps. I wouldn’t want to pick a side – so will be watching it as a neutral (although a shock pause and cut would be appreciated as it’ll bring the cost of my upcoming holiday to Spain down)

Have a brilliant week! As always – As always, I’m in the forum as @IamJacka – Feedback, challenges, criticism, ideas and thoughts are always welcome.