Did the Panic Market Adjustment Reach a Climax?

Before the weekend, the S&P 500 closed above its opening level for the first time in seven sessions.  It did not close the opening gap, but rallied strongly into the close, encouraged by hints from somber Federal Reserve Chairman Powell that a rate cut is likely.  Powell has been criticized for striking wrong chords in press conferences and statements. Still, he did well this time as he indicated greater flexibility than the mantra that has been dragged out repeatedly about how the economy and policy are in a good place.  When Powell talked of a midcourse correction, he used language that indicated three rate cuts.  His promise to "act as appropriate" is understood by many Fed-watchers to signal a rate cut at the March meeting.  

Like many, we thought that investors had exaggerated the upside in many risk assets. That it is exaggerating the downside is what markets do.  It acts like a servo-mechanism.  Imagine you are taking a shower and at first the water is too cold.  You move the handle to get hotter water, but now it gets too hot, so you push it back.  And you go back and forth until you find it, but the markets never find "it." 

While the US market may have seen a selling climax, the technicals suggest the dollar's sell-off against the yen and euro may have more room to run, even if some consolidation is seen first.  The greenback rallied strongly against the other major currencies and the Mexican peso and finished outside its Bollinger Bands.  It suggests the market has moved too far too fast and cautions against chasing the dollar now.   

Dollar Index: The Dollar Index fell 1.1% last week to snap a three-week rally. It was the largest weekly decline since last June and finished the week (~98.13) in the middle of this year's range (~96.35-99.90).  The next retracement objective (61.8%) is near 97.70, just below the 200-day moving average (~97.85).   The MACD and Slow Stochastics show strong downside momentum.  The five-day moving average crossed below the 20-day for the first time since January 10.  Corrective or consolidative upticks should not extend beyond the 98.70-99.00 band if the downtrend trend is still intact.

Euro:  The 1.65% advance was the biggest weekly advance in two years.  It was the first back-to-back advance this year.  The powerful short squeeze, we suspect, was largely a consequence of unwinding of levered positions that used the euro to fund the purchases of other assets, such as stocks or gold.  The euro reached nearly $1.1055 ahead of the weekend, just shy of the (61.8%) retracement objective (~$1.1065) of this year's decline.  The upper Bollinger Band begins March near $1.1075, and the 200-day moving average is near $1.1100.  Although the technical indicators reflect the strong momentum, some near-term consolidation is likely. Support is expected in the $1.0915-$1.0950 band.

Japanese Yen:  The dollar was probing the JPY112 area on February 21, reaching an eight-month high, and a week later, it tested JPY107.50, a four-month low.  It was as if the levered accounts who are short-vol trades and the carry-trades capitulated last week, and the yen was often at the center.  When everything was said and done, the dollar fell 3.3% against the yen, its single biggest weekly loss in nearly four years.  The dollar closed below its 200-day moving average (~JPY108.40) and its lower Bollinger Band (~JPY108.20).  The technical indicators show the strong downside momentum, we suspect there is room to back-and-fill.  A move above the JPY108.50 area could signal another big figure advance.

British Pound:  The selling frenzy took sterling to almost $1.2725 ahead of the weekend, its lowest level since mid-October.  Sterling was also under intense downward pressure against the euro.  It met the (50%) retracement objective of the rally that took sterling from below $1.20 in early September to almost $1.3515 in mid-December. The MACDs are over-extended, but the Slow Stochastic did not confirm the recent lows, having bottomed around February 11.  Initial resistance is seen in the $1.2850-$1.2860 area.  A break of the 200-day moving average could signal a move toward $1.2550.

Canadian Dollar:  As oil was pummeled and risk-aversion jumped, the Canadian dollar was punished.  The US dollar's nearly 1.4% gain was the largest since the end of 2018.  The market moved to discount a stronger chance of a rate cut on March 4.  A week ago, about 5 bp ((~20%) of easing discounted and now nearly 20 bp  (~80%).  The US dollar reached CAD1.3465 ahead of the weekend, its highest level since the middle of last year.  The technical indicators are consistent with additional greenback gains. However, the greenback has finished the previous two sessions above the upper Bollinger Band (~CAD1.3380). Initial support is likely in the CAD1.3335-CAD1.3365 area. 

Australian Dollar:   The Aussie began the week near $0.6625 and plunged to $0.6435 ahead of the weekend.  It recovered to about $0.6535 in the North American session before finishing near $0.6515, still below the lower Bollinger Band (~$0.6530). The recovery raises the prospects that a selling climax has been witnessed.  The MACD is near a 2-year low while the Slow Stochastic bottomed several weeks ago.  A move above $0.6550 would be constructive while resurfacing above $0.6600 would suggest a low of some import may be in place. 

Mexican Peso:  The dollar will take a seven-day, 6% rally against the Mexican peso into the week ahead.  It reached almost MXN19.90 ahead of the weekend, which had not been seen since last August, before easing back to about MXN19.64.  It began the surge from around MXN18.55.  Of course, the momentum indicators are pointing higher, but the dollar finished every session above the upper Bollinger Band.  While the Bollinger Band will move toward the price, we expect the levered community to jump back into long peso positions, attracted by the nominal interest rates, which are relatively higher now.  Initial support may be seen in the MXN19.40 area. 

Chinese Yuan:  After finishing above CNY7.0 for six consecutive sessions, the dollar finished just below there (~CNY6.9920) ahead of the weekend.  Chinese markets are faring relative better than most.  The Shanghai Composite fell 5.25% last week, and yuan was one of the few currencies that rose against the US dollar last week.  The onshore yuan rose by about 0.5%, and the offshore yuan gained 0.8%.  Since China's markets re-opened on February 3, the greenback been in a range roughly between CNY6.95 and CNY7.05.  The technical studies on the offshore yuan suggest further strength is likely in the coming sessions, which means there is a risk that the dollar slips through the lower end of the range. 

Gold: The price of gold peaked on Monday near $1690 and proceeded to sell-off alongside risk assets to hit almost $1563 ahead of the weekend.  That means that last week, gold retraced more than half of its gains since dipping below $1460 in early December 2019.  The 50% retracement was about $1574, and the next retracement objective (61.8%) is found a little below $1547.  The MACD and Slow Stochastic have turned down, which suggests the downside move has more room to run.  However, the prospects of lower rates for longer may support the yellow metal.  On a 60-day rolling basis, the correlation of the percent change of gold and the S&P 500 is typically inverse. That inversion reached a four-year extreme near -0.67 on February 21 and reached -0.17 ahead of the weekend, its least inversion since last August.  

Oil:  Light sweet crude oil for April delivery has a six-day losing streak in tow.  During the streak, it has fallen by about 17% to finish February below $45 a barrel (generic contract) for the first time since July 2017.  If the drop is sustained for any period of time, many shale producers will be hit.  It is not that they cannot produce oil cheaper, but their "break-evens" need to include the fixed cost of their debt.  Sustained lower oil prices will also impact investment decisions, and the oil patch was a key driver.  The market does look stretched, and the April contract closed below its lower Bollinger Band for the past two sessions.  A move above $48 would help stabilize the technical tone.

US Rates: The US 10-year yield fell 32 bp last week to 1.15%.  It has fallen for seven consecutive sessions and began the streak with a yield near 1.57%.  While a decline in inflation expectations may have played a role, the change in expectations of overnight money (Fed policy) may have had a more significant role.  Consider that the implied yield of the December 2020 fed funds futures contract has also fallen for the past seven sessions.  In that time, the yield has fallen by 45 bp.   Powell's statement before the weekend may have eased ideas of an inter-meeting move, but appears to have boosted the risk of a 50 bp move.  The implied yield of the March fed funds futures contract closed February at 1.365%.  Assuming that the average effective rate remains at 1.58% until the Fed meets on March 18 and the Fed cuts by 25 bp, fair value is about 1.475% yield, and 50 bp cut would suggest fair value is closer to 1.33%.  

S&P 500: The S&P 500 gapped lower three-times last week, including on Monday, where the gap now appears on the weekly bar charts as well (making it a more important technical signal).  None of the gaps were closed, though Powell's statement before the weekend appeared to have sparked a recovery that entered the gap.  That gap is the first hurdle and is found between Thursday's (February 27) low (~2977.4) and Friday's (February 28) high (~2957.7).  There has been much technical damage inflicted.  Beyond the gap is the lower Bollinger Band, which the S&P 500 has closed below for the past four sessions, is found near 3016.  The 200-day moving average is near 3047, and the initial retracement (38.2%) objective is near 3060.  

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