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False dawn or not

Commentaries & Views

S&P 500 jubilation continued yesterday, and markets didn't really notice Fed's Williams throwing cold water on giving up the fight against inflation prematurely. The excessive moves in USD retreat well below 111.50 throughout yesterday, and plunge in Treasury yields combined with very risk-on posture in junk corporate bonds, provided daily continuation of Monday's momentum (the bear trap having characteristics of a short squeeze), with real assets beyond oil amplifying the growing risk appetite. At the same time though, VIX didn't sharply retreat – 29 is not plunge target to speak of, which demonstrates to some degree a fragile nature of this two day upswing. Remember the title of yesterday's article (Fed Turn That Wasn't) and the caution in evaluation of the upswing prospects I called for back then:

(…) with a lag, markets are forcing the Fed's hand – there has been no catalyst for yesterday's broad-based upswing, yet every asset class is acting as if Powell already pivoted – or paused, as it could be euphemistically called too. The Fed isn't yet wobbling in its determination, no shoe has dropped that would force it to reverse course. Markets are only acting as if the Fed already folded, and as I wrote yesterday, are assigning lower probability to steep hikes in Nov and Dec than was the case two weeks ago – but there hasn't been a crisis that would force the Fed to blink.

That crisis would of course happen abroad, not in the States – there are plenty of European banking concerns as evidence in rising CDS, sovereign yields, energy crisis, slowing manufacturing, slowing consumer demand, housing, and of course strong inflation data abroad, which the strong dollar helps to offload elsewhere. The tail risks are high – no matter the markets acting as if they were over already, as if the Fed backed off as a result – as much as markets are forward looking, that isn't isn't guaranteed to happen soon.

Could this be the start of the Q4 rally I called for yesterday to arrive rather in 5-7 sessions instead? Hard to say now as yields would have to follow lower still (think the 10-year breaking conclusively below 3.50%), and the dollar would have to make a lower low. We're in no man's land currently, and should the rally progress with similar momentum today as was the case yesterday, without any bearish divergencies such as bonds unable to rally (risk-on mode), real assets no longer amplifying the S&P 500 upswing, appear during today's regular session, then the bears are in a serious short-term trouble.

For now, I'm still leaning towards the stock market advance at least stalling, and starting to form bearish divergencies – the rally of the last 36+ hrs has been excessive, broadening, and can be called a stampede. Now, it's up to the herd to stop, and realize that it hadn't run on any good reason. All it takes is Powell & co not folding immediately – it's my view that just as it took the markets longer to force the Fed to raise, it'll take a while to force the Fed to relent. The only and real question is whether that happens still this year, or only in 2023.

The premarket series of tweets shining light on the overnight happenings, describes that well. While we haven't seen a bearish stampede reversing the prior excessive moves, Williams not blinking would make the markets realize that inflation fighting is still on. It's up to ECB and not the Fed to see their bluff called first anyway. So far, we're seeing an orderly correction in stocks after 3,770s were broken, and commodities not outpacing the declines in non-USD currencies and Treasuries. Today's objective for the bears is to decisively break below 3,720s if they are serious about downside acceleration.

While the real economy is slowing, the Wednesday's part of non-farm payrolls data (lagging indicator, remember this is a lagging indicator) isn't obviously going to reflect the recessionary fears, and would thus feed into the "Fed has no reason to stop tightening – there's enough leevay still" narrative, so stocks should understandably decline on such a good news sinking in. Clearly the pivot / pause bets are very premature. At the same time, I'm looking for relative resiliency in real assets – look how little oil has budged (driven by OPEC+ of course). Gold and cryptos are to dial back their upswing to a much lesser degree than silver, or copper.

The fate of the Q4 alleged start is being decided this week.

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