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S&P 500, Dollar, GBPUSD and Monetary Policy Talking Points

  • The Trade Perspective: S&P 500 Bearish Below 4,000; AUDJPY Bearish Below 90; EURUSD Bullish Above 1.0650
  • Risk aversion accelerated and broadened to start the new trading week with the S&P 500 notching its worst three-day plunge (-7.2%) since the pandemic with most markets taking a hit
  • Sentiment can be its own motivator, but the more familiar lightning rod for traders will be monetary policy led by Fed speculation through US inflation expectations

Does This Qualify as ‘Blood in the Streets’?

There is a saying in investing and trading that goes “buy when there is blood in the streets”. The perspective is one of a contrarian view where panic overrides rational decision making and markets are likely to reach a terminal velocity in its crash. To be fair, I’ve seen discussions in headlines and among speculators that markets had already corrected as far as was reasonable back in January. There is an underlying thrum to these markets that the bullish appetite will eventually and inevitably win out…for no other reason than it has simply been that way for a number of years. Yet, as confidence in the central bank put drains away and recognition of financial and economic constraints grow; recognition that ‘markets can also go down’ is gaining more serious prominence. I would say there is ‘blood in the streets’ now, but that doesn’t mean that the markets are near the end of their stumble. To start this week, the benchmark risk measure I like to follow – the S&P 500 – was down another -3.2 percent. That not only pushed the index to its lowest point in 13 months, but it is also edged the index’s loss to a three-day total slump of 7.1 percent for the worst performance over that stretch since March 23, 2020.

Chart of S&P 500 with 3-Day Rate of Change (Daily)

Chart Created on Tradingview Platform

We are in the midst of a fairly broad swoon in risk leaning assets that includes all of the major US equity indices. While the S&P 500 is the most ubiquitous index in portfolios around the world (particularly through its many derivative forms), there are perhaps better measures of the intensity of sentiment – be it bullish or bearish. A benchmark comparison I favor as a gauge of sentiment rolling down the speculative hill like an avalanche is the ratio of the Nasdaq 100 to the Dow Jones Industrial Average. Both are US equity indices of great prominence and are therefore reflective of investor appetite. However, the NDX has led the charge for risk seekers over recent years as the combination of top market cap component companies and their supposed disruptive value led to commanding gains. That position seems to be working against the market in this current phase, however, with the NDX to DJIA ratio dropping to its lowest level since June 2020. It has been quite turn from the double top at the Dot-com boom/bust record high.

Chart of Nasdaq 100 to Dow Ratio with 200-Week Moving Averages (Weekly)

Chart Created on Tradingview Platform

Measure ‘Risk’ In a Big Picture Way

While I continue to track the performance of the US indices for my overview of general sentiment, it is not the most accurate gauge of conviction. Many will say – and have said to me – that the ‘why’ of market moves is irrelevant because we are already heading along the prescribed course. I would argue, however, that the motivation for a systemic move is very important as it will factor in heavily as to whether there will be follow through or not. And what greater question is there in the speculative rank now other than whether the slide we’ve entered is just an exaggerated pullback or the bow of a genuine trend reversal? All of that said, my preferred gauge for systemic sentiment is founded upon a combination of the breadth and intensity of ‘sentiment-driven’ market positioning. For our current situation, it was clear that global equities were suffering right along with the S&P 500. What’s more, there was further confluence from emerging market asset, junk bonds, cryptocurrency as well as havens like government debt.

Chart of Risk Sentiment Level Across the Financial System

Chart Created by John Kicklighter

For the FX trader, the spillover of risk aversion would find its way through a typical channel for the market: carry trade. While there is some discussion around what constitutes a carry nowadays, the Japanese Yen based crosses remain the most ubiquitous players among the yield-seeking drive. Up until last week, it seemed that all JPY-backed pairs were impervious to scrutiny; but that hold has seriously crumbled since peaking in late April. Among the more traditional Yen crosses (for those that have been in this market for over a decade like myself), there were some serious technical patterns to contemplate. While NZDJPY was perhaps one of the deepest contractions thus far, I am far more enamored with AUDJPY which is still sorting out its full commitment to a reversal with a head-and-shoulders pattern still standing and the 50-day simple moving average still standing as support at 90. How much of a fight will that floor raise?

Chart of AUDJPY with 50-Day SMA and 1-Day Rate of Change

Chart Created on Tradingview Platform

The Dollar and the Data

I believe risk trends to be one of the strongest forces in the global financial system generally, and it is specifically a top variable for our medium-to-long-term course at present. That said, this theme isn’t always a convenient one-dimensional reflection of the markets. Consider USDJPY. Both the Dollar and Yen are often treated as safe havens, but they are not simply an harbor of stability in all financial squalls. Rather, the Dollar is a safe haven of the type for those seeking liquidity at all costs. As for the Japanese currency, it isn’t actually a haven in for international investors under most circumstances. Rather, Japanese investors will generally invest abroad under normal circumstances because decades of low yields has necessitated earning yield outside of the country. When conditions globally grow tumultuous, it leads those same Japanese market players repatriating their capital. So what is the stronger force with USDJPY: the strong carry trade drive or the abstract risk aversion potential? I will be watching to see the market’s call when it makes one.

Chart of USDJPY with 20-Day SMA and COT Net Spec Positioning (Daily)

Chart Created on Tradingview Platform

In the mix of market influences, it can be difficult to track back to the more elemental track of ‘sentiment’. That said, I believe monetary policy remains one of the more driving measures of our markets’ performance. After a range of countries have reported their consumer price gauges have breached multi-decade highs, it is not a surprise to see numerous major central banks commit to getting back ahead of the inflation curve. That has translated into a relentless drive to cub inflation even at the expense of market performance and even economic expansion. We really have not seen that recognition that the ‘central bank put’ is no longer in place; but it will seep in eventually. This past session, the US docket offered up consumer inflation expectations with a modest cooling in the tempo from 6.6 percent one year forward to 6.3 percent. That didn’t seem to translate into any softening of rate speculation. Ahead, Wednesday’s docket offers up the US April CPI which will give us another data point, but don’t expect the Fed to just sit idly by as a spectator. Of rate expectations continue to pressure an existential review of risk taking, expect the central bank to parade its members with language aimed at soothing the pain. There are a lot of Fed official speakers on tap today…

Calendar of Major Economic Events

Calendar Created by John Kicklighter