Is the Fed losing the battle?

It was not very long ago that Fed Chairman Jay Powell told the world that the US economy was “in a good place”. President Donald Trump told us that the economy had never been better. In a very short time, the world has turned upside down.

In May 2007, the then Fed Chairman Ben Bernanke said that he didn’t believe the growing number of mortgage defaults would seriously harm the economy. He assured that the effect of the troubles in the subprime sector on the broader housing market will be limited. We all know where that ended for all of us.

The truth is the guardians of these institutions of power know nothing better than the man on the street. Probably, the man on the street knows more better as he can at least think outside the box.

The actions of the Fed in the last two weeks makes us think that there is nothing more the Fed can do to make a situation worse. But, hold on, we will develop that in detail below. Today’s report is going to be long and probably interesting for serious readers.

While stocks were plunging, participants were running into the safety of bonds. But that equation has changed. After making a climatic rise in bonds, yields lower, yields have started to rise sharply in the face of a recent surprise rate cut by the Fed. With that the Fed came in strongly on last Sunday slashing rates to zero and starting a $700 billion bond buying program.

Powell was strong in words that his desk at the Fed would “go in strong” on Monday buying treasuries across the curve. That kind of statement should spook any speculator out of the market immediately and should be more than enough to normalize the market, but it didn’t turn out that way.

With the Fed funds rate at zero, the 10-year yield traded as high as 1.26%. So far, the Fed is losing the battle.

Last week, and this week so far, a few large hedge funds were said to be in forced liquidation. When this happens, they tend to sell what they can, not what they want to. They are forced to purge on their long bond and long gold trade.

Conventional wisdom will tell you as the world’s central banks are printing money, throwing it like “confetti” and governments are rolling out massive deficit spending programs, gold should be soaring higher. But it’s down 13% since last Monday. We will cover more on this in the gold section.

As with the bond market the Fed has the printing press, and overtime win the battle in the markets, think the Fed will guide the 10-year yield to 40 or 50 basis points and be in control of the yield curve. We need to reassess Gold whenever that happens in the market.

Bloomberg pointed out that the 4-week US treasury bill yields are now negative at -0.0102% which means investors are paying the US treasury to hold their dollars for the next 4 weeks to 3 months. You deposit your money in the bank, and you receive less money back when you withdraw your money.

Another thing one must consider is the US banks don’t have your dollars on deposit, they’ve lent them all. What happens when a number of these loans turn sour and depositors in masses demand their deposits back? We will discuss that later in another report.

If you are an ardent follower of the equity markets, here is something you want to know. The closing NYSE Trading Index (TRIN) has been below 1.20 every day except one since Mar 4. TRIN closed at 1.8 on Mar 11 and for the past five days it has closed below 1.00 every day. TRIN is derived by the dividing the advance/ decline ratio by the upside/ downside volume ratio. When stocks rally, TRIN tends to fall and when the markets tends to fall, TRIN starts to rise, which reflects the concentration of volume in rising and falling stocks.

E.g. when stocks were crashing in Oct 2008, at the height of the credit crises, TRIN was rising strongly closing above 2.50 at the time. But that’s not what is happening now. Stocks have declined sharply but 5 Day TRIN closed yesterday at .79. In other words, stocks are falling despite buyers attempt to push them up. At some point, the buying power will get exhausted and stocks will fall further.

Equities

Both the Dow and the S&P 500 closed bear their highs for the day but there were 15 times more stocks down than up on the NYSE and the volume in down stocks was 93.2% of total volume. The S&P 500 continues to decline in a succession of lower lows and lower highs. The Dow closed below 20,000 for the first time since Feb 2017. The late day rally keeps the nervous bears from remaining bearish and lures bottom picking bulls into believing that the worst of the decline is now over.

As mentioned in the last report, the area surrounding the 2350 area is important. It is not only the 2018 Dec low but a.382 fib ratio retracement of a primary up move. The S&P declined to 2280 yesterday intraday but managed to close at 2398. So, somebody is watching this range. Doubt this level will hold. The progressing wave structure as well as alternate interpretations indicate there is further weakness before this weakness is complete.

Bonds

The junk to US treasury credit spreads continue to explode higher rising to 148% since the Dow peaked on Feb 12. The widening has increased to 846 basis points suggesting strongly the pressure on stocks remains on the downside.

Credit is contracting which in a credit-based economy is strongly deflationary. The volatility in the long bonds is tracking the stock market volatility. After prices peaked on Mar 9 at 191^22 yesterday’s sell off drew bonds to 167^05 intraday a very big move. Think prices should drive down to 155 area. Near term resistance should be in the range of 175 to 177.

Euro

Euro has retraced almost all its rally from the 1.0778 low on Feb 20. The stress in the cross-currency swaps is the main issue. The size of the retracement decreases the confidence in our bullish outlook and should it break below the Feb 20 low, we will turn neutral on the Euro.

Gold

Trading in Gold has been a nightmare. Apart from equity indices, it is the most volatile major traded instrument but much less liquid. As I have mentioned before, it is one of the most technically traded instruments.

It looks like in the short term the move from 1451 on Mar 16 to 1549 on Mar 17th was corrective. The structure is counter trend. Price should break below the Mar 16 low in the coming days. But based on everything else that is happening, one needs to be agnostic on gold as well. Will develop more on this in the coming days.

Be small, be safe.

Abraham George is a seasoned investment manager with more than 40 years of experience in trading & investment and portfolio management spanning diverse environments like banks (HSBC, ADCB), sovereign wealth fund (ADIA), a royal family office and a hedge fund.