I am position trading interest rates
So, how high will US rates go before the Fed starts cutting them? That’s the big question on the minds of pro investors/traders. To guestimate their projections they pore over every detail of the stream of US economic news for the best trading strategy.
And that is why we see such volatility in the stock indexes around such days when important data is released. Recently, the Dow has swung up/down/up by 600 points in a flash as I recorded in last week’s blog What is the best swing trading strategy for the Dow now?
And not so long ago, the consensus for the peak in Fed Funds (PFF) has been drifting upwards from an estimate of under 5% a month ago to the recent 5.3% (Flash: Friday prints at 5.5% post – PCE).
This surge in rates is not a great surprise to yours truly as I am on record of stating last year that interest rates would rise to much higher levels than most could imagine. It will be higher-for-longer – and shock the majority (slowly over time, then suddenly).
I have covered the effects of inflationary pressures – which have been moderating – and that should impact PFF guestimates lower. But it is not, as is being demonstrated by the new high yields in the Fed Funds futures.
The downtrend in crude oil, which has been in effect since January, has now been picked up by the MSM as they note gas/petrol/diesel prices have fallen for consumers. Inflation is falling, right? So let’s buy shares – no?
Using the time-tested theory that when an established trend has been noted in MSM headlines, it is about over. Any resurgence in energy prices would place a brick wall in the consensus ‘falling inflation’ story and send it shooting back up (with a delay).
And that is what appears to be happening with Brent Crude having tested the $80 line-in-the-sand OPEC floor this week. Friday’s sharp reversal down/up in energy markets is flagging the corrections are likely over.
Question: What if market interest rates (slavishly followed by the Fed) keep climbing with only brief and shallow pauses in a higher-for-longer scenario into next year? What if the universally-accepted narrative for a peak in rates followed by a pivot is wrong? What if rates soar (as they did in the 1970s and 1980s?)
And what if inflation does not moderate now? What if rising bond yields translate into a tsunami of corporate bond defaults? I believe that is a realistic option in the EU and USA.
This is already happening in China of course with the gargantuan Evergrande property group defaulting on some of its bonds last year. All it would take to kick an off entire collapse of our financial system is is for rumours of a large company or group to be on the brink. That may already be happening.
With bloated debt levels everywhere, this is not such an outlandish suggestion.
Incidentally, for concrete proof of how the Fed follows the market (not the other way around, as is popularly believed) – here is the killer proof
Follow the stair-step moves by the Fed – they always try to catch up to the (higher) market rates. They lag, not lead.
I see very few, if any, pundits are contemplating the much higher-for-longer option. And that is why it is a very real possibility.
Remember, markets exist to frustrate the majority (the crowd). And a strongly rising rate scenario would most definitely do that. Here is a terrific illustration of this effect in action.
For most of last year, US retail investors have had a bias of bearish (AAII survey) to bullish and into January as markets declined. Two weeks ago, they suddenly turned net bullish for the first time in many months with retail buys setting a record pace.
They could stand by and see themselves missing out on the strongly advancing markets no longer. They just had to buy.
And the power of FOMO grabbed them by the throat – and they just had to get back in and did so en masse – right at rally highs.
This yet another example of the public being addicted to the Buy High, Sell Low school of investing success. Here is a revealing chart (from 2020). The maximum spread bull (red)/bear (blue) occurs when the peaks occur.
This law is as old as the hills.
And naturally, that rush of bullish FOMO marked the high for the bear market rally of 12,900 in the Nasdaq on 7 February (the strongest index to recover). It now trades in the 12,000 area (down 7.5%).
Note that in the above chart, the only times when there are slightly more bulls than bears is when the market spikes hard down to a major low. These were terrific contrarian buy signals of course.
And the same meeting of the red and blue lines occurred a few days ago. That also marked the major high in shares.
With the dollar now recovering, what is my forex trading strategy?
Since my basic thesis is that US interest rates are on a solid bull trend, I have been expecting the deep correction off the September high in the dollar to reverse.
And on 1 February, reversed it did – on a strong mom div. The Elliott wave labels above that I favour is only one of several possible. It calls for a wave 4 rally (in three sub-waves?) to my target around 106. It is from there that it will either conform to my roadmap by declining in a fifth wave, or continue the rally.
I will need to see the various wave patterns over the next few weeks to decide.
But for now, the trend is up – and remember, the trend is your friend. That is, until it isn’t.
The largest component of the dollar index is the euro by far, much will depend on the market’s reaction to what the ECB will be doing about interest rates. For now, it is interest rate differentials that dominate.
Because of the fragile status of the dominant German economy, the ECB are walking on eggshells when deciding rate policy. Can they afford to match the Fed? Can they afford not to?
Remember, not so long ago some EZ sovereigns were trading with negative yield (guaranteed to lose money if held to maturity) – a monstrous anomaly and a result of the extreme manic belief that rates would stay lower for longer. How times change when inflation rears its ugly head.
Of course, a weaker euro is usually welcomed by EU exporters where Germany dominates. But just as the Fed follows the market, so does the ECB. I note that EZ inter-bank rates are 2.6% compared with the US Fed Funds rate of 4.6% – 4.75% – a wide spread.
The euro is heading lower (for now).
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Burberry makes a fashion statement
A little off piste but as an avid follower of women’s fashion, I couldn’t help noting the latest collection for the leading UK fashion house Burberry. Below is one of the more striking ensembles and I note that the dress and the coat both are long almost to the floor (as are all of the others in the collection).
It immediately brought to mind the Hemline Indicator that has variously been supported and debunked in equal measure. If it is working today, it is following share prices lower.
I just thought you would like to see what women will be wearing this season (or not). Scary, no?
OK, back to the real world….
NatGas has crashed but what is the best trading method now?
This commodity is always in the news. And it has been living up to its well-deserved reputation of carving out huge boom-and-bust cycles. And currently, it is in a deep bust phase.
From the last summer high of 100 it has plunged to a low on Wednesday at 21 – a decline of 79% in just about six months and at a level last seen in July 2020. For true traders, these kinds of moves light up their eyes in wonder at the possibilities for gain.
But the severity of the drop back to near historic lows on oversold oscillators such as the RSI has my eyes lighting up and the possibility of large snap-backs.
In recent months, consumers have been lowering their thermostats to try to avoid bankruptcy and industrial users in Europe have been shutting down operations for similar reasons. This has produced a glut of spot US supplies and has pummelled spot prices.
But of course the cure for low prices is always low prices. The question is: How low do prices have to sink to induce a more balanced supply/demand relationship?
As ever, I turn to the charts.
The ‘c’ wave is certainly long and strong and has taken the RSI to the 30 ‘oversold’ level. Note that it reached that level only twice before in 2020 from where large rallies were launched. Will history repeat this time?
If it does, I can see a fairly rapid climb back to the 52 area. But remember, trading commodities such as this one is fraught with surprises in the shape of sharp pull-backs.
And a move from the current 26 to 52 on a modest £10 spread bet would produce a cool profit of £25,900. Nice.
But this market must contain a lot of stale longs just itching to escape relatively unscathed – a recipe for such pull-backs.
Any thoroughly professional trading strategy, such as my Tramline Trading method, must include solid risk management rules. And that is what I will do with this setup.
We will be trading it for the VIP Traders Club members.