What an overnight trading session. And what an opening first hour for US stock markets. US stock markets were red, and looked ready to tumble. We saw red candles in the Asian session (Hang Seng and the Nikkei, but the Shanghai Composite remained stable), and sell offs in Europe. Across the pond the French CAC was the hardest hit, followed by the UK FTSE and the German DAX. The Spanish IBEX is the only European market that I watch which remained in a range. We still have one hour to go before the European session closes, and currently they have pulled back just a bit. More on this later.
So what is putting pressure on the stock markets? It wasn’t anything geopolitical, but the Federal Reserve. The tapering saga continues, and it seems to be approaching its crescendo.
Yesterday the markets received FOMC minutes from July. These are basically meeting notes from the Fed’s last meeting in July. It gives us an insight into what Fed Presidents are thinking. This becomes very relevant when traders and investors are determining how tapering will impact the stock market.
Interest rate hikes seem far away…even though Fed President Bullard believes rates should increase sooner due to the inflation. The inflation which is supposed to be temporary (transitory) hence we don’t need to worry about it. But tapering is the big topic.
Currently the Fed is spending 120 Billion per month buying treasuries and mortgage securities. This is their asset purchasing program.
As long as this balance sheet moves up, stock markets are to follow. Hence why many analysts state that this stock market rise is all because of cheap money. This is the danger of the taper tantrum. The fear that stock markets will begin to sell off and enter a bear market once the Fed reduces their purchases, and then looks more likely to raise interest rates. It would mean the end of cheap money.
To gauge the fear, I look at the US Dollar and Bonds. This is the fear trade. We will take a look at all of this, and markets under technical tactics. But first, let’s cover the FOMC minutes released yesterday.
From yesterday’s statement, the markets are now expecting the Fed to taper sometime this year. A consensus to begin scaling back the $120 billion bond purchases is forming.
“Most participants noted that, provided that the economy were to evolve broadly as they anticipated, they judged that it could be appropriate to start reducing the pace of asset purchases this year,” the minutes said.
The minutes said several officials favored reducing asset purchases in the coming months in order to better position the Fed to potentially raise interest rates if the economy strengthens further next year, while others thought the Fed could wait until early next year because they want to see stronger evidence that the job market has healed from the effects of the coronavirus pandemic.
As you saw from yesterday’s price action…US stock markets sold off. Is the fear trade now beginning with the taper tantrum?
Technical Tactics
Bonds and the US Dollar are the charts to watch for the fear trade. Money runs into the safety of bonds and the US Dollar.
Bonds gapped up. The candle has a red body, but it can easily flip back to green by the end of the trading session. If TLT sells off, then there is a better chance for the stock markets to recover.
The US Dollar is breaking out. But the Dollar might not be rising because money is buying for safety. It is rising due to tapering and then eventual rate hike expectations. I still think the weekly close above 93 will be a huge macro event. This will impact precious metals, commodities, and emerging market countries with large US Dollar denominated debt.
In terms of US stock markets, if this is a taper tantrum, we should expect to see another leg lower. If we continue to rise, it means two things. Either the market doesn’t believe the Fed tapers (maybe Delta variant causes issues) and cheap money and asset purchases continues, or investors believe there is nowhere else to go for yield.
The Nasdaq is the stock market I am watching like a hawk. Today’s daily close is going to be important, as the Nasdaq broke below a flip zone on yesterday’s close. The retest, as expected, is occurring today. Now we wait to see if sellers pile in, or if bulls manage to nullify the breakdown by taking us over the 14,900 zone.
If not, then another leg lower is in the cards. I should mention that Dr. Michael Burry from the Big Short fame, has decided to short Cathie Wood and ARK. The fund is pretty much all tech, and many have asked the question before: “how does ARK hedge if the Nasdaq falls?”.
The S&P 500 on the other hand is at a major support level. Technically, this level was the previous higher low. Meaning if we close below this, then the uptrend is over for now, and we make a retracement. There are two things that can happen here. Firstly, we just bounce and continue to make more record highs. The uptrend continues. Or secondly, we form a topping pattern. What I have drawn above would qualify as a head and shoulders pattern.
I won’t cover the Dow Jones because the chart looks exactly like the S&P 500. Either a topping head and shoulders, or we move on to make record highs.
The Russell 2000, or the US Small Cap Index, is back at our dangerous level. A broad range going back to the beginning of this year. We tend to see this index lead the others, so if we breakdown…it would be a big sign. Not to mention it would also mean the end of the small cap bull run. Yikes.
Going forward let’s keep our eyes on Bonds, and the US Dollar. The market expects the Fed to announce tapering sometime in the next two meetings. The markets might be volatile until then.