This market remains a head-shaker, with an odd combination of resilience in risk and a weakish dollar, while bonds and JPY have snapped to attention a bit on ugly data from the US. The initial claims data was ugly once again as we enter the summer period when jobless claims traditionally rise until early to mid July. (This seasonality is adjusted out of the data releases that everyone follows, but still interesting to note that the claims are still rather high during this period.) The Philly Fed survey fell drastically short of expectations, at 8 vs. the 20 expected and 21.4 in May. That was the largest drop since June of last year. The internals showed that much of the drop was due to a very large drop in the prices paid and received components, which is bit of a relief, though it was more than discouraging that the Number of Employees component fell to -1.5, the first negative reading since last November. Optimists will note that New Orders rose for the month to a solid 9.
Looking at our risk indicators, we note a dramatic bifurcation in the market, with emerging market spreads, junk spreads and central bank forward expectations continuing to show high risk aversion in the market. Junk bond spreads have ratcheted higher almost every day of late and are close to touching a new 10-month high. Meanwhile, equity volatility, FX volatility and to a lesser extent corporate CDS indices continue to improve at a rapid pace, with the first two of those now all the way back to the neutral threshold, an amazing divergence.
Below we have a look at a couple of our risk indicators vs. equities and at equities vs. AUDUSD, which has been one of the currency pairs most consistently correlated with risk.
Chart: Junk Bond Spreads and Equities
We worry about junk bond spreads because they often serve as a leading indicator on the status of risk appetite elsewhere, especially at big market turning points. Here, we can see that junk spreads have continued to head wider (this is an inverted spread on the chart below, so wider spreads equals lower levels on the chart for the blue line indicating these spreads), while risk in the form of equities has squeezed higher.
We worry about junk bond spreads because they often serve as a leading indicator on the status of risk appetite elsewhere, especially at big market turning points. Here, we can see that junk spreads have continued to head wider (this is an inverted spread on the chart below, so wider spreads equals lower levels on the chart for the blue line indicating these spreads), while risk in the form of equities has squeezed higher.
Chart: Equities and AUDUSD
This chart shows how the FX carry trades like AUDUSD tend to more or less follow the equity market. These two markets are likely to continue moving in synch with one another. AUDUSD got a bit overexcited back in late 2009 on the hawkish outlook from the RBA. Since then, the market has pulled back sharply on its forward.
This chart shows how the FX carry trades like AUDUSD tend to more or less follow the equity market. These two markets are likely to continue moving in synch with one another. AUDUSD got a bit overexcited back in late 2009 on the hawkish outlook from the RBA. Since then, the market has pulled back sharply on its forward.
Chart: Rate expectations and AUDUSD
Here we chart interest rate expectations as expressed by the 2-year swap spread (two years out being about the farthest that a central bank can influence rates). This shows us that if the risk appetite move continues higher, an AUDUSD view of 0.90+ would be warranted - especially as the rate outlook is often a part of the risk outlook. We would be surprised for this move to continue for that long. The next key resistance levels for AUDUSD are the 55-day moving average, currently at 0.8850, and the 200-day moving average currently at 0.8980.
Here we chart interest rate expectations as expressed by the 2-year swap spread (two years out being about the farthest that a central bank can influence rates). This shows us that if the risk appetite move continues higher, an AUDUSD view of 0.90+ would be warranted - especially as the rate outlook is often a part of the risk outlook. We would be surprised for this move to continue for that long. The next key resistance levels for AUDUSD are the 55-day moving average, currently at 0.8850, and the 200-day moving average currently at 0.8980.
Chart: USDJPY
USDJPY traversed the 200-day moving average today, but at the New York close doesn't look like it wants to close firmly below this level. It seems this rally in risk is hitting the greenback harder than the JPY.
USDJPY traversed the 200-day moving average today, but at the New York close doesn't look like it wants to close firmly below this level. It seems this rally in risk is hitting the greenback harder than the JPY.
Looking ahead
This market makes little sense as we outline above. We'd be happier to allow for more leeway on a solid bullish rally here if the indicators and fresh economic data warranted such, but they don't. Nonetheless, this market can go anywhere as it has already shown and the squeeze could yet continue higher in the short-term as it seems so willing to ignore important developments and normal fundamental tethers. This may be about positioning and possibly option expiration tomorrow, so let's see how we close the day tomorrow and open the week on Monday as a test of the short squeezers' moxie. Divergence in risk conditions tells us we shouldn't believe in the move, but don't tell us how ugly the divergence may yet become.
This market makes little sense as we outline above. We'd be happier to allow for more leeway on a solid bullish rally here if the indicators and fresh economic data warranted such, but they don't. Nonetheless, this market can go anywhere as it has already shown and the squeeze could yet continue higher in the short-term as it seems so willing to ignore important developments and normal fundamental tethers. This may be about positioning and possibly option expiration tomorrow, so let's see how we close the day tomorrow and open the week on Monday as a test of the short squeezers' moxie. Divergence in risk conditions tells us we shouldn't believe in the move, but don't tell us how ugly the divergence may yet become.
So stay careful out there as always.
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