The Trump Effect is falling apart! – Feb 26
The last three months have been dominated by the Trump Effect: the expectation of inflationary growth based on election promises and subsequent policy hints. The consequent effect was dramatic: rising US yields, US Dollar and US stocks. We have highlighted this as typical of the last leg of a stock and USD trend (viz 1929 and 1987). It is the perception and therefore sentiment that drives this seemingly unusual triangle and last leg not necessarily the fact. It is partly this difference that leads to an also typical break down in correlations. This observation has been supported so far by a lack of substance from the Trump administration: the difference between rhetoric and action. It has also been supported this week by a striking disintegration of the triangle. US stocks have continued to rally, the USD has remained fragmented but flat and US yields have broken down.
In isolation, one could be forgiven for seeking a continuation of each of these three different trends. Together they suggest a very interesting week not least because one forex pair is clearly leading the Dollar Index and therefore flagging risk aversion. They also highlight a change in trading strategy for both Indices and Forex.
This is a note we will be sending out to our trade signal subscribers:
The US stock market has emphatically confirmed our long held view of a 1929 style blowout – a market few of us have ever traded before. Even though some may remember trading its copy in 1987, the market and instruments to trade such a market is quite different now. Although there were options back then, there was no VIX.
At Matrix, we make a great thing about evidenced based analysis and talk less (but think more) about evidence based trading. It is arguably even more important in what is potentially the best trading market of at least a decade.
Our tactic of suspending the take profit limits on our DAX 11156 SPX 2244 and DJIA 19776 longs has clearly been justified by the level of subsequent volatility beyond the SPX 2300/2351 DJIA 20,700 DAX 11430 technical targets. We were and still are convinced the Trump rally would accelerate beyond most people’s expectations. But by how much has been and will be difficult to measure and only becomes clearer (with time) in the latter (but not very final) stages. This is not a technical market but certainly a sentiment driven possibly not a fundamental driven market (as the move has been predicated on perception of Trumpflation rather than inflationary growth itself). Where sentiment takes over volatility is even harder to gauge. USDCAD’s blowout last year is the best recent example of ‘silliness’.
For the US Stock market this requires a careful and continuous assessment of how high before how low before it goes up again eventually to the ultimate 2515 SPX objective . In other words how silly it will get. As soon as SPX hit the 2330 region we believed and still believe any further strength will not be sustainable without an eventual major (possibly straight line) retracement back at least to those levels if not a shock correction back through 2300 to our entry points. Hence why we hedged SPX and now DJIA at 20820. The Matrix (risk/return x probability) metric shifted significantly against holding longs without protection. But as we cannot be sure of how high it goes first we hedged rather than closed our longs. After all we could possibly have ended up taking off the hedges at break even for the next 100 point SPX rally. However, now we have had more definition with time we can be more confident of a major retracement. Since VIX remains at historically low levels it presents a massive divergence between implied and actual volatility.
Since picking an interim top remains both difficult and dangerous this suggests a change in strategy. We will no longer rely on cash trades and hedges. As the week starts possibly with another new high, we will exit our arguably more over-extended DJIA long and hedge and start taking advantage of a low VIX by buying relatively cheap puts. As SPX could try to catch up on this possible blowout we will delay the cash and hedge exit by as much as 48 hours or so but still buy puts. We will leave fine tuning cash shorts until we can identify a clear Matrix (risk/return x probability) set up that works.
In short we will exit longs and sell early week strength looking for a return to 2330 possibly even lower. Given a likely hike in VIX on any such drop we may end up using the low VIX entries to buy cash against.
A careful continuous assessment requires flexibility that both hedges and vix-driven options can provide. We are lucky. Traders in 1987 and 1929 did not have that flexibility.
We will also introduce a similar change in Trading Strategy for Forex. We continue to identify 100-200 pip moves as part of a potential larger trend. But these larger trends are not materialising as yet. Rather than continue to hedge the trades, it may be better in some cases to ‘hit and run’. This will allow greater flexibility that the break down in the Trump Effect demands.
For a more detailed explanation of our hedging strategy please see http://www.matrixtrade.com/hedging/
Thank you to all those who attended the London Forex Show on Friday. I was flattered and worn out to have been asked to address the three main audiences of the show. Its not ever day that an ex-politician gets to address hundreds of people on his favorite subject.
Next week we will publish the second article in the Milestones in Mania series focussing on the fundamental drivers of the 1929 and 1987 style blowout in US stocks.
0700 EUR German PPI Beat
What we said at the time (for the week)
This weekend we have highlighted how and why such bubbles can challenge people’s expectations of normal volatility. Milestones in Market Mania is the first of 7 articles aimed to help us trade the third largest US stock bubble in history.
We have and will continue to make a big thing of the break down in correlations in this phase. The US should generally outstrip most other markets,. However, there will be times when other markets catch up either due to local factors or a dampening of US Trumpflationary expectations. This week provides one such opportunity.
DAX has continued to follow the ‘Trump Correction’ now suggesting a textbook retracement is unlikely before an aggressive break higher
The Forex market should remain somewhat erratic this week within consolidation ranges, mirroring the consolidation in the US yields. Although Trumpflation remains the main driver of most markets, where US yields aren’t volatile, currencies are likely to be buffeted by local factors.
Today sees the start of the House of Lords debate on Any diversion from the Government line is likely to see GBP strengthen but for how long is open to debate as well. Similarly today also sees the start of Greek debt negotiations with pressure on Greek bonds but the scope for a livelier EURUSD towards the end of this week into next is probably more likely to come from developments in the French or German elections. The JPY continues as a somewhat subdued risk animal.
Monday was President’s Day and US Markets were closed. Unsurprisingly, markets were flat, except the NKY which rose in the Asian session, and FTSE which faded slightly in response to an equally slight rise in GBP. Even the German PPI beat at 0700 only spiked DAX 40 points which it immediately gave up to settle into a 30 point range all day. Other than GBP, currencies were mostly flat.
0030 AUD RBA Minutes
0830 EUR German PMI Beat
1000 GBP BoE Governor Carney spoke
1445 USD PMIs Miss
2130 AUD RBA Governor Lowe spoke
What we said at the time
The critical variable for stock indices today is volatility. Although markets still appear relatively subdued after the US holiday and the US uptrend in particular need of consolidation, there is a window for something more dramatic. Much will depend on the US later today then as to whether they will post a sharp extension to 2368 and help trigger catch up in European stocks. DAX continues to follow similar Trump SPX price action before breaking aggressively to new highs.
The Forex market continues to dance to the tune of Trumpflation with a few local variations. Despite the keenness of some to force it and seek trend, they will mainly be disappointed for 2 clear reasons and charts.
USD strength is unlikely to be sustained with one or two exceptions. USDCAD has broken wedge resistance and just needs to clear out 1.3210 to see a deceptively overlong CAD market bail out.
The second reason is political and debt (Greece) uncertainty in Europe ironically serves to trap currencies in the range until resolution. Uncertainty and Greece also invokes the uncertainty fractal that EURUSD followed before the Greek referendum, GBP before Brexit and to some extent EURUSD before the Italian referendum. The likeness is striking and exactly in line with our ‘ Washington’ EURUSD scenario of a whipsaw declining wedge (See EURUSD evidence charts).
The third reason is the break down in correlation still highlights scope for better levels to sell both AUDUSD and NZDUSD and flagging what currently seems an unlikely Euro-Commonwealth major reversal.
Just as the stock market continues with the ‘Buy, Buy, Buy’ theme so currencies are singing ‘Fade, fade. fade’
The Trump rally resumed on Tuesday, DAX was straight up after the German PMI beat at 0830, then SPX and DJIA followed (ignoring the US PMI miss at 1445), the latter making another record high. FTSE and NKY didn’t join in.
Currencies were mixed, AUD, GBP (after a dip through BoE Governor Carney’s speech before the US opened) and gold were flat, but USD was very slightly up against JPY and CAD (the latter despite oil’s rise), and more so against EUR. 10-year yields were also flat
0900 EUR Germany IFO Sentiment Beat
0930 GBP UK GDP mixed
1330 CAD Retail Sales Miss
1900 FOMC Minutes
What we said at the time
Global stocks have confirmed suspicions of an aggressive blowout to the most aggressive phase of the uptrend.
SPX remains the bellwether index with potential to extend and DJIA the potentially the beneficiary with a 20901 target. However, despite the volatility of this move some indices are lagging due to local factors
What a mixed bag Forex is at the moment. We are so conditioned now to explain things away in terms of Trumpflation, days like today seem perplexing. And yet it is very clear what is going on today. Concerns over France are overshadowing a US dominated market waiting for FOMC minutes.
German-French Bond spreads are therefore under pressure as investors shy away from anything French and rush to safe haven German Bunds. Reference to the 10 year differential chart shows how this is probably overdone today above -80 but probably not the end of what appears to be a corrective decline. Presumably this implies Le Pen doesn’t win.
This helps maintains our view that EURUSD weakness is not sustainable.. yet and also helps explain a completely fragmented Forex market.
As SPX goes into a probably fait accompli FOMC Minutes today it is creating the ideal bull trap. Confirmation that the Fed may well raise rates in March in the first of three hikes in 2017 should pass uneventfully and allow the market to buy SPX to new highs for the final time probably for a week or so. From there it will be at risk of the first major correction since the break of 2300.
After Tuesday’s rally, equities took a breather on Wednesday, and were all flat, (except DJIA which again added 50 points made a new high). This is very unusual on the monthly FOMC Minutes day, reflecting the fact that very little was said by the Fed that was not already known. Only FTSE rose slightly but this was probably because of the GBP fade, assisted by the mixed GDP figures are 0930. CAD faded on the retail sales miss at 1330, and oil giving up Tuesday’s gains, but otherwise the other currencies (EUR AUD JPY) were flat against USD.
0700 EUR German GDP a/e
1330 USD Initial Jobless Claims Miss
1600 WTI EIA beat
What we said at the time
Global Indices continue in a near term climax to the most aggressive stage of this historic 1929/1987 style blow out.
This phase is characterized by
1. Divergence between actual and perceived fundamentals (ie sentiment)
2. Typical break down in correlations.
If this is a short term blowout these characteristics are likely to be accentuated.
1. Superficially yesterday’s FOMC minutes appeared relatively dull. They reiterated the growing consensus that March will probably produce the first of three rate hikes in 2017. However, they were possibly the most revealing in a long time (not least the repeated reference to the USD). One of the reasons why the text appeared less hawkish than some expected was the implied difference between actual fiscal policy and effects AND perception – the hallmark of a blowout. The minutes therefore emphasized the need to follow the data and didn’t exclude downside risks with the curious exception of downplaying geopolitical risks into a dangerous French election. The impact of the minutes was, as expected, the typical resumption of blowout potentially into a late Friday-Monday top.
2. The scale of breakdown in correlation (divergence) is key to the extent of this short term blowout. DJIA is leading a lagging SPX. Nifty is creating a possible bull trap between the 2 historic highs. French CAC may also still be in consolidation but continues to threaten the 4920-4930 highs. Either of these breaking without their currency taking the slack will likely fuel the global blowout.
The Forex market is currently dominated by two overriding themes: The ‘Frexit’ risk posed by Marine Le Pen to European stability in the forthcoming French elections. And Trumpflation: the extent to which Donald Trump’s mooted fiscal expansion will drive inflationary growth and interest rates. Neither are clear and therefore serve to continue erratic Forex trading within the range.
Two similar themes at very different stages in their cycle. The Frexit risk, highlighted by the Le Pen’s first round lead but most likely diffused in the final round, serves to depress safe haven Bund yields and consequently the Euro and ‘risk’ pairs most notably EURJPY. By and large it is USD neutral as evidenced by the fragmentation of USD pairs when France is to the fore such as the last 72 hours. Trumpflation on the other hand serves to drive higher the USD higher (EURUSD lower) and risk pairs higher via rising yields and stocks. Since the market appears currently to swing from one to the other on news events, most Forex markets should be, and are, erratic but range bound. The theoretical exception is the EURUSD which should, by rights, be much lower. So why isn’t it? Uncertainty. It is a textbook cliche that uncertainty depresses currencies but the reality is different. Ironically uncertainty also serves to limit the extent of the currency weakness until a resolution as reflected by the EURUSD uncertainty fractal.
(See EURUSD uncertaintly fractal above)
The outcome of the French election is still fairly unclear as also reflected by the German-French spread chart that presumably projects the more obvious Le Pen defeat.
Uncertainty is also a recurrent theme in Trumpflation. Donald Trump has mooted fiscal expansion but we are yet to see the ‘phenomenal’ tax cuts and their subsequent effect. A point that was made clear in FOMC minutes with their dependence on data as opposed to political rhetoric.
“Participants cautioned against adjusting monetary policy in anticipation of policy proposals that might not be enacted or that, if enacted, might turn out to have different consequences for economic activity and inflation than currently anticipated.” FOMC. What was interesting was the repeated reference to the stronger USD that serves as a counter inflationary alternative to interest rates. “The downside risks from the possibility that longer-term inflation expectations may have edged down or that the dollar could appreciate substantially further were seen as roughly counterbalanced by the upside risk that inflation could increase more than expected in an economy that was projected to continue operating above its longer-run potential.” Not the clearest or shortest of sentences but counterbalance has the effect of keeping yields and USD range bound at the very least or limiting the scale of any rise. A stronger USD will reduce the inflation and yields and therefore limit USD strength.
If we could have picked a scenario that would suggest a slow erratic USD turn (Washington Euro), it would have been an uncertain Trumpflation and an uncertain Europe. We can thank Donald Trump and Marine Le Pen for that.
Effectively no change in our Forex outlooks.
After German GDP came in at 0700 Thursday as expected (1.2% YoY), DAX gently faded, while other indices (SPX NKY FTSE) stayed flat for the day, although SPX made a new intraday high, as did the rarely monitored FTSE All-World Share Index. However, ignoring the US jobless claims miss at 1330, DJIA again made another 50 point new closing high. USD definitely faded on Thursday against all currencies and particularly GBP which rose 133 pips (1.07%) although it gave up all this on Friday. Gold also rose sharply putting on 1.25% at one point to reach a three-month high. 10 year yields started a fade to 2.38% (1.4% rise in bond prices), CAD was up, as the EIA beat at 1600 pushed up oil.
1330 CAD CPI Beat
What we said at the time
Global stocks remain buoyed by the cheering prospect of Trumpflation and buffeted by the worrisome French elections. The most vulnerable to developments in either remains the Bund-driven DAX as it comes to the end of its catch up week. Although it still has potential to extend the uptrend, a warning shot has been fired by US stock divergence (between DJIA and SPX) and an inability to maintain new highs despite more Trumpflationary comments from Steve Mnuchin, the US Treasury Secretary. Not phenomenal but “very significant” tax reforms within the next six months and a curb on regulations could boost US gross domestic product growth to at least 3 per cent by the end of the year. This momentum loss from US will place greater emphasis on Bunds staying high (2 year German yields made new lows yesterday) and EURUSD below 1.0600 if DAX is to maintain its catch up week. The fact NIFTY is also struggling at two year new highs suggests the global uptrend may pause and keep both Nikkei and FTSE within their ranges – for now.
We did not issue our afternoon Forex bulletin on Friday as we were at the London Forex Show.
On Friday initially equities fade quite sharply in the Asian and European sessions, but rise again in the US session. This was not enough for NKY, DAX and FTSE, but SPX finished the week on an all-time high, and DJIA did its 11th straight all time high close, finishing 185 points (0.90%) up at just over 20800. The index has put on 2950 points since the day before the Trump election. To put this in perspective, it took the three and half years up to Nov 8th, virtually all of Obama’s second term rise a similar number of points.
The currency and commodity picture was again mixed. USD was down against CAD and a material 94 pips against JPY, yet up against GBP and EUR and an equally notable 52 pips (0.67%) against AUD, the latter being remarkable as gold (for which AUD is a proxy) put on another nine dollars (0.72%) for another 2017 record as oil faded some of the previous day’s gain. What was not ambiguous was the 10-year yield, which fell 77 basis points to 2.304% (a 3.22% rise in bond prices) to new 2017 low.
President Trump addresses Congress on Tuesday, and all eyes will be on his tax reform proposals. We will be watching this, along with Fed speakers to get hints about rate rises, as TreasSec Mnuchin was not forthcoming about detail last week. If we don’t get anything substantial, the markets may drift. A raft of US consumer data is also out, along with GDP on Tuesday. Canada’s rate decision this week is on Wednesday (no change expected), along with a raft of German data. Also the important US Manufacturing PMI is at 1500. Focus on Canada continues on Thursday with GDP at 1330.
There are four FOMC member speeches this week, Kaplan and Brainard speak on Thursday and Fischer, and Chair Yellen speak on Friday.
CALENDAR (high volatility items are in bold)
Mon 27 Feb
1330 USD Durable Goods
2145 NZD Trade Balance
2350 JPY Retail Sales
Tue 28 Feb
0000 GBP UK Consumer Confidence
0200 Trump speaks to Congress
1330 USD GDP
1330 USD Consumption
1500 USD Consumer Confidence
Wed 01 Mar
0030 AUD GDP
0100 CNY Manufacturing PMI
0855 EUR German PMI
0900 EUR German Unemployment
1300 EUR German CPI
1330 USD Consumption
1500 CAD Rate Decision
1500 USD Manufacturing PMI
1700 Fed Kaplan speaks
2000 Fed Brainard speaks
Thu 02 Mar
0030 AUD Trade Balance
0930 GBP UK Construction PMI
1330 CAD GDP
2330 JPY CPI
Fri 03 Mar
0145 CNY Services PMI
1445 USD PMI
1700 Fed Fischer speaks
1800 Fed Yellen speaks