Written by Jim Welsh
Macro Tides Weekly Technical Review 17 June 2019
Financial markets expect the FOMC to either lower the fed funds rate at this week’s meeting on June 19 or tip its hand regarding its next meeting on July 31. The fed funds futures market pegs the probability of a rate cut no later than at the July meeting at 83%. With so many investors expecting so much clarity from the FOMC at such an uncertain time, the odds of a disappointment may not be 83% but is surely north of 50%.
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I think the odds of the FOMC cutting rates at the June meeting are less than 10%, since the FOMC has clearly fulfilled its mandate for maximum employment, and isn’t far from hitting its 2.0% inflation target, especially if one looks at the Dallas Trimmed Mean Inflation Rate (TMIR) which was 2.0% in April. The FOMC has estimated the non-inflationary GDP growth potential at 1.9%. Although GDP growth has slowed from 3.1% to near 2.0% (Atlanta GDP Now is 2.1%), it is near or above the FOMC’s 1.9% speed limit. It’s hard to imagine why a majority of FOMC members would believe the economy needed a boost unless GDP was below its long term growth potential.
If the FOMC doesn’t deliver a rate cut, investors will scrutinize every word of the FOMC statement and Chair Powel utters during his press conference hoping to determine that the FOMC will act at the July 31 meeting. My guess is that Powell will hit it right down the middle of the fairway and repeat what he said back on June 4. Referring to the trade negotiations Powell said:
“We do not know how or when these issues will be resolved. We are closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2% objective.”
This is a pretty innocuous statement but investors were surprised that the FOMC was actually monitoring the trade negotiations and would, can you believe it respond if the trade negotiations threatened the sustainability of the expansion. On June 4 the DJIA rallied by more than 500 points in response to their enlightenment and not to any change by the Fed. So one never knows how investors will ‘interpret’ the FOMC’s statement or Powell’s post meeting comments. If the FOMC does not lower the funds rate and Powell says nothing more than the obvious (we will act as appropriate to sustain the expansion), my guess is the stock market will fall as investors are disappointed.
As noted last week, there are two triggers that would spur the FOMC to lower rates: Weak data that confirms the economy is slowing more rapidly than expected or, President Trump levies tariffs on the $300 billion of Chinese imports not currently subject to tariffs. Another round of tariffs and retaliation by China would likely lead the FOMC to execute a rate cut before economic data confirmed the anticipated weakness. Until then the FOMC is data dependent.
Focus will also be on the FOMC Dot Plot which is updated quarterly. Back in March the Dot Plot showed 11 officials expected the fed funds rate to remain unchanged through 2019, 4 thought the rate would rise by a quarter point and 2 expected a half point. I suspect there will be no FOMC members projecting 2 rate hikes in 2019 and the number expecting 1 reduction could probably shrink as well.
There is also the chance the FOMC will suspend the balance sheet runoff (QT) at the end of June rather than waiting until September 30. This decision would take some of sting out of not lowering rates and allow investors to infer that this is the FOMC’s way of letting them know they will cut the funds rate at the July meeting. Reality is often formed by the perception of what people want than what is.
Stocks
The pattern in the S&P 500 since January 2018 has formed a Classic ‘megaphone’. The high in January 2018 would be labeled wave (3) from the March 2009 low. (See chart below) The decline to the low in February 2018 is wave (A), the rally to the September 2018 high is (B), and the plunge into December 2018 is (C). The May 1 high may be all of (D) or will be complete after a quick dip that likely holds above 2820, followed by rally to a higher high above 2954. A close below 2800 would be a warning that Wave D ended on May 1. On March 7 the S&P 500 traded down to 2722 and fell to 2729 on June 3, so this price level (blue horizontal line) is Key Support. A close below this level would likely indicate that Wave D did top on May 1, and lead to a quick drop to 2630 – 2650. A test of 2630 – 2650 seems likely in coming months.
Click on any market chart below for large image.
If the Megaphone pattern is correct the S&P 500 would be expected to drop below the December low of 2347 to complete the Megaphone pattern and Wave 4 from the March 2009 low. Should the S&P 500 rally above 2954 in coming weeks, it would provide conservative investors the opportunity to become more defensive and a shorting opportunity for aggressive investors.
Treasury Bonds
Retail Sales for May were stronger than expected and April and March were revised higher. Control Group Retail Sales were up 3.4% from May of last year and the 3 month annualized rate jumped to 8.5%. Although the 3 month annualized rate is not sustainable, it does show that consumer spending is continuing at a healthy clip.
This news was largely ignored by those hoping for an ‘insurance’ rate cut no later than July. Members of the FOMC are not likely to overlook this strength since consumer spending is almost 70% of GDP.
Positioning in the 10-year Treasury futures is supportive of another push lower in yields since Large Speculators have amassed a large short position. TLT is expected to push above $132.58 in coming weeks which could complete the rally from the low in October.
The bond market may react less negatively than stocks since global bond yields (Ex-US) are now at their lowest level in history.
Dollar
From its recent high of 98.37 on May 23, the Dollar index declined in what looks like a 5 wave pattern. This suggests that the odds are now high that the Dollar has indeed peaked and is likely to drop to near the low on January 10 at 95.03. After a 5 wave move either up or down, a counter trend move typically follows. I thought the Dollar could bounce to 97.37, which is wave 4 of lesser degree. On June 17 the Dollar reached 97.60, just below the 61.8% retracement of the decline from 98.37 to 96.46. If the FOMC decides to not cut rates and the markets conclude the FOMC or Powell didn’t provide assurance of a cut in July, the Dollar could move above the high of 98.37. The Dollar is still expected to drop to 95.03 in coming months. Positioning in the currency market indicates that the Dollar is a crowded long trade and suggests that the next big move is down not up.
Gold
As long as Gold remains below $1367, Wave (d) of the triangle since July 2016 has merely thrown a curve by pushing above $1347 and reaching $1358 last week. If Gold does negate the triangle, then Wave (e) of the triangle bottomed at $1266 rather than below $1250 as expected. Should Gold push above $1367 the expected rally to $1450 or higher has already begun.
Positioning in Gold futures lowered the odds of a breakout as the number of long contracts increased significantly as of June 11. Three weeks ago Gold was a stretched short but the recent rally has enticed Large Speculators and Managed Money to jump on the Gold band wagon. If the FOMC doesn’t drop the funds rate or hint of a cut at the July meeting, Gold would be expected to fall. If Gold drops below $1320 establish a 33% position in GLD or IAU using $1301 as a stop. Establish a 33% position in GLD or IAU if cash Gold trades at $1367. This is not the ideal entry point as a decline below $1250 would have been.
But the opportunity of a rally above $1400 and higher has been developing for almost 3 years and it would be a bummer not to have a position on, if Gold runs due to more tariffs on China.
Gold Stocks
The Gold stock ETF (GDX) appears to have completed 5 waves up from the low on May 2 so a corrective pullback seems probable. There is gap on the Gold stock ETF (GDX) at $21.74. The RSI for GDX reached 73.7 on June 17 so GDX is overbought and vulnerable to a modest correction. The RSI for GDX would be expected to drop below 50 and maybe get close to 40 before GDX tries to rally again. Establish a 33% position at $21.80 since GDX is likely to close the gap.
Tactical U.S. Sector Rotation Model Portfolio: Relative Strength Ranking
The MTI generated a Bear Market Rally (BMR) buy signal on January 16, 2019 (green arrow) and climbed above the green horizontal trend line on February 26 confirming the uptrend. The progressive weakening in the technical structure of the market since late April led me to reduce exposure. When the S&P 500 was trading at 2877 at 7am on May 16 I lowered the exposure in the Tactical U.S. Sector Rotation Model Portfolio from 100% to 50%. I lowered exposure to 25% in the Tactical U.S. Sector Rotation program on June 11 after the S&P 500 gapped up to 2903 at the open.
Disclosure
The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Russell 2000 Index is a small-cap stock market index of the bottom 2,000 stocks in the Russell 3000 Index. The Nasdaq 100 is composed of the 100 largest, most actively traded U.S. companies listed on the Nasdaq stock exchange. All indices, S&P 500, Russell 2000, and Nasdaq 100, are unmanaged and investors cannot invest directly into an index.
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