Recent Animal Spirits and Some FX Dynamics
First, let me start by stating how poor my read was on HY in my last article. I grossly underestimated the level of fear in debt markets and grossly overestimated the potential for large capital to reach for yield.
The USD’s ascent should have told me everything I needed to know, that the extremes in credit volatility were just getting started.
Mid-Summer has arrived and with it a slackening in fear. We can review some market extremes near the end of the article, but it’s important to first address forex dynamics and their current impact across markets.
The USD is the sun in our forex solar system, and really the financial system. It’s movement affects all other currencies, commodity pricings, and is an effective gauge of animal spirits.
A few weeks back, the USD looked toppy. I contended that the USD would correct which would kick up animal spirits for risk. All we needed to validate that hypothesis was not so bad earnings, an anticipated CPI, and GDP to be shrugged off. Lo and behold, all three happened while commodities were in the midst of a breather, thus reducing expectations for next month’s CPI.
The dollar is key right now as it is getting a temporary reprieve as a must-have haven.
Maybe I’m not reading the room correctly. It happens. Bloomberg journalists seem to think so.
Article from last Wednesday (7/27/2022):
What’s funny is that the dollar had already turned over and yet this still went to print. Bloomberg articles about the dollar have a pretty solid track record the past year as a contrary indicator.
Here’s a few more articles and a chart of the USD notating time of publication and the exact opposite move occurring:
Which all begs the question, where to park if not in dollars?
The Yen is the obvious carry and capital is flowing. The European economy appears worse than the US. At least the US has energy. So flows into the Euro will probably be muted. The pound is seeing play because it reached an extreme. That leaves the commodity currencies, CAD & AUD, but that’s not going to cut it. Which leaves the Swiss Franc. The Franc is still a trusted haven-currency and I believe it’s volatile past several weeks portended the move in the USD.
While the other reserves were diving, the Franc was chopping upward. The Franc’s action looks like confused capital; almost like a begrudging acceptance as a dollar alternative in the current environment. I happen to think this also portends a move in gold as the Franc and gold share a long-term love affair defined by a consistent correlation.
It appears gold is ready for some action and it could be sustained action. I suspect gold’s move will be predicated upon it’s perception as a reserve asset. Despite punching above it’s weight economically and financially, Switzerland cannot sustain inflows and the SNB will just defend its currency anyway. This leaves gold as a non-USD alternative haven that can handle the capital inflow to an extent.
$1775 (green) was the first line of resistance and it was met quickly. $1915 (yellow) should be next. If gold gets there then the USD should have already breached $103 support with $99 as a potential stopping point. After $1915, all time highs past $2080/oz are blue sky. These numbers are “ish” numbers, not exact calculations as foretold to me by an astrologist.
Blue sky is great. But with a controlled asset like gold, excitement needs to be tempered. Yes, gold is a powerful currency, however it’s held in check. That’s fact. New all time highs will ensure it won’t be long before we hear the foolish siren calls of $5k/oz or even $10k/oz. any second now.
So don’t get too excited but now might be a time to start dabbling in the shiny metal.
Back to the stock markets.
When I was contemplating the dollar’s down-move and how to play the uptick in animal spirits, I projected the S&P 500 to maybe crap out at about 4175, a hi-lo move of 15%. But now I’m not so sure. We hit that number quickly so a short breather might be in order. Markets have to give bears a chance to say, “See, I told you so.” Before a potential final move higher.
Large capital will be waiting to sell at 4200, but the dollar’s descent has more room to run. Additionally, there’s massive amounts of skeptical capital that missed this last move. Between chasing and squeezing I wouldn’t be surprised if the S&P 500 hits 4315-ish. But that should fill the belly and satiate the bulls in this bear market rally for a rough hi-lo move of 18% – 20%.
Now if you’re a skeptic of the recent rally, you’re far from unique. How can you not be considering the economic and geopolitical situation in which the world resides?
But of course, there were only dozens of data points indicating the extremes in the stock markets, flashing bright neon yellow signs to buy. Here’s a smattering of charts in case you missed them weeks ago.
After a 15% run higher off the lows, the S&P 500 does not have much more room to run so some profit taking this week could set the stage for the final leg of the bear market rally.
As this goes to print, equities are in day 2 of some corrective action and the USD is seeing inflows. Nothing moves in a straight line. Watch the currencies closely to help guide your macro-decision-making.