A new stage in the bull market

We enter a new and crucial stage in the multi-year cyclical bull market, with the S&P 500 now commanding a 'two' handle and showing little sign the bulls will let their grip slip.

S&P 500
Source: Bloomberg

If you want to point to a negative from yesterday’s US cash session, it has to be the awful volumes, which were 30% below the 30-day average and 11.5% below the five-day average (on the S&P 500).

If you believe it’s not always about getting from A to B in the markets, but the quality of the journey, then the recent volumes would be a concern. However, volume in isolation is not enough to warrant broad-based short positions and, as detailed in recent narrative, a long bias is still favoured.

Is the Fed behind the curve?

US data continues to hold up and, in some cases, actually looks very upbeat. One can look at the recent July leading indicators, Philli Fed business outlook (the highest print since April 2011), Richmond Fed manufacturing (highest since March 2011) and yesterday’s conference board confidence report (highest since October 2007) – making an argument that certain leading surveys suggest the Fed is perilously close to being behind the curve.

The fact US treasuries have not sold off too aggressively suggests that fixed income managers would have a preference to allocate funds here, as they have to look compelling on a relative basis. The fact that other developed market bonds have fallen to such low levels is keeping US yields contained. However, if you look at the Fed funds rate (an interest rate instrument), we have seen a slight increase in the last few days around future Fed tightening. This is keeping the USD supported.

It’s interesting to see such one-way price action in the FX market, which seems testament to the clear and ever-emerging divergence seen in at the central bank and political level. Traders who use momentum-based strategies will be raising a glass, as we’re finally seeing strong and textbook downtrend in pairs like EUR/USD and GBP/USD, with limited counter rallies. Trends have also been seen to a lesser extent in USD/JPY, EUR/AUD, EUR/CAD and AUD/NZD.

I have been a USD bull for some time – a fairly consensus view. It was, however, always about timing the trade. It must be said that the US dollar index is overbought and due a slight retracement, but on current news flow you have to be quick and fairly nimble to buy pullbacks.

It just seems illogical that we’re going to see a major reversal in the USD, especially with the market now warming to the idea of another bout of interest rate cuts from the ECB either in September or October – potentially taking the deposit rate to negative 20 basis points. We could even see the central bank talk about the launch of asset-backed security purchases, while some would say we’re already seeing market pricing reflecting an element of full-blown public asset QE – although this is many months off in theory.

European politics ever-present

The French political dramas have been aiding the EUR downside. The term ‘Grexit’ was commonly used in 2012 (as fears of Greece leaving the EMU caused huge volatility), but we haven’t seen anything similar yet. The fact that French bonds are outperforming Germany’s is telling a clear story, although it seems we are some way from seeing investors looking at France as a major default risk.

François Hollande has until April 2017 to lower unemployment, reduce debt and try to create confidence that will see the Socialist party re-elected. This is clearly not going to happen under the current policy setting, and fragmentation at a party level is not going to help. Markets are concerned The National Front leader, Marine Le Pen, is a front runner, although Nicolas Sarkozy is still the bookies’ favourite.

On a more short-term view, Asia has seen little volatility and traders have largely sat on their hands regardless of asset class, although the CAD (with Burger King bidding for Canadian firm Tim Horton) and NZD have seen some buyers. The ASX 200, Nikkei and CSI 300 have done very little, with US futures not moving much as a result.

Our opening calls for European markets are moderately lower, although it certainly doesn’t feel that markets are going to roll over anytime soon. The interesting dynamic is we are seeing the European banking sector really diverge from EUR/USD – a correlation that was strong until July. This suggests that the market now has a firm  ‘ECB put’ in play, with poor data resulting in an ever-increasing chance of QE. This will invariably light a rocket in their share prices. On the data side, we get French business confidence, as well as German and Italian consumer confidence figures.

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