Weekly Overview For July 1st

This week ended the second quarter on very shaky ground. After last week Bernanke’s spook of the markets, this week the Fed sent out a bunch of Bernanke troops to calm the markets. Apparently most took Bernanke’s Fed statement last week as a time table for a pull back and final end to QE sending stocks and bonds south. This week Bernanke’s sergeants came out in droves, to correct the markets supposed misinterpretation of a time line for a fundamental one—being that a possible pull back would only be in order if economic fundamentals improved. Most of the media and FX news pages focused on the concern for equities falling off; however, I really do not believe that was the concern for the Fed as much as interest rates were.

Stocks were due for a correction. The S&P had been on a steady march up since the 1342.35 November 16th low gaining 345 points and were ripe for a good correction—something any market could handle. The real scare, which is still being played down, is the rise in bond yields.

This is the killer and I am surprised that most analysts are clueless to this fact. I read an article in the New York Times that was pleading help for the states and municipalities—wanting more of the same poison that got them in trouble to begin with. But I was taken aback by the accuracy of the reporting on the real dangers that waits the states and muni market if bond prices kept rising. In a nut shell the article was complaining about the high interest rates city and states had to pay for the bonds being sold for city and state projects and in some cases payment for rolling over debt. Some cites were unable to sell bonds at these rates and were standing back waiting for interest rates to come down, so that they could resume their projects currently on hold. And even worse, the article added that Detroit, on the brink of default, wants their bond holders to take “haircuts” making this if, or I should say when, it happens, the biggest muni bankruptcy in US history. Furthermore, Illinois, with their broke pensions system, was having so many problems with interest rates at these levels that Moody’s and Fitch downgraded their bonds to A2 and A-. The articles tone was beseeching implicitly for the Fed to do something to keep these evil interest rates from government’s public works. The article was surrounded by a picture of a highway construction site abandoned during rush hour. If yields are already causing this much havoc now, just imagine at a 10 yield of 3.5, 5, 6…? Something that is very likely at this rate this year.

All this and there was no mention about the US government and its own version of adjustable rate mortgage, which happens to be the biggest elephant in the room with their massive unfunded liabilities and government debt financed at the low end.

As for housing, Freddie Mac said that the 30 year mortgage rate surged to 4.46% from last week’s 3.5%, the biggest weekly jump in 26 years. This means that in just one week a person buying the same house has to make 10% more to cover the 1% increase in rates. Now I know that a small part of the media and pundits that have paid attention to this recently will have you think that it could very well just be a temporary over reaction fear spike that will correct itself.

And take notice that a healthy rate of interest rate is 1.5% to 2% above the inflation rate. Being that today’s inflation rate is 1.5 that would put the 10 year yields at 3 to 3.5%. The 10 year yield today is only at 2.5—one whole percentage point under that, and the interest rate sensitive markets are all crying uncle already. And one cannot ignore the possibility that inflation is being under reported today, which would make the real yield much higher.

According to Bloomberg, Fed official Lacker said he opposes continuing asset purchases because they weren’t worth the risk. Just what risk is he talking about? Aren’t these risks already here? And this statement along with all the talk of the markets over reacting is supposed to make me believe that the Fed could actually stop buying soon and things would be ok? I don’t know what else Lacker said, but I am most inclined to think that he is implying that it would be prudent to stop now before anything bad were to happen, which I agree with in part because stopping now would be better than the bigger disaster unfolding; however, as for the US economy being able to sustain itself, I really don’t think so. The pain of restructuring will be felt long and hard. Maybe the stock markets is the new canary in the coal mine—the real problem being debt. Rising interest rates are already causing some massive overextended markets some serious problems that can cause the whole house of cards to come tumbling down; and, these last two weeks were proof. The Fed has to figure out how they are going to keep interests rates from rising.

It does look like the Fed assuaged the markets somewhat for the S&P gained almost 3% while Yields pulled back a little over 5%. However, on the charts things still look very precarious. Taking a look at the US 10 year yield it looks like the bond yield has finished off a fourth wave black iv and is now turning up to begin a fifth wave to complete the larger degree magenta bracket iii. Wave five’s target is at the 2.71% mark—black wave five’s equalization with wave 1. Also notice how the Awesome Oscillator has retreated to below the zero line—a good confirmation that a wave four has completed. However, as I mentioned in last week’s weekly, the momentum in this third wave is strong, with shallow retracements making it possible that this wave three could extend further. Not a good scenario for the markets.

The US 10 YEAR YIELD

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This week the indexes all over the world rallied off last week’s sell off. In the US the NASDAQ rose 2.9%, the S&P was up 2.5% and the Dow up 2.21%. From a weekly perspective things looked good for US equities. Over in Europe the FTSE was up 1.59%, the DAX 2.27% and the EUSTX50 plus 2.4%. In Asia, the Nikkei rallied a good 4.64% while the Hang Sang moved up 3.38%. Sentiment picked up after the Fed reassured markets that QE was still on. Not only did the Fed come out to remind the markets that a pullback was pending economic fundamental an not dates, but it also added that purchases could increase if had to–Something I think is more likely. It seemed like things were getting back to normal with Stocks rising and yields falling a bit.

However, technically things still look very weak. Notice the nice impulsive waves down on the S&P starting from the May 22nd high. The rallies are corrective while the moves down impulsive with the first move a textbook leading diagonal and the next wave of lower degree a nice expanding five wave move. However since the two moves down just about equal in price the move down could very well be a completed zigzag. The move up doesn’t look too convincing though for it is choppy in the middle and could go either way as correction or impulsive move up. Notice how the index is resting at the 1 hour tunnel. If this is only a correction then it should break down there Monday. However, if the index moves up above the tunnel then it will strengthen the zigzag scenario and the index could very well head on up for a new all-time high.

THE S&P

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The US Dollar index moved up a second week in a row closing well above the filter, wave and tunnel on the weekly leaving the index with the path of least resistance up. Notice how the buck is still well bid regardless of the recent rallies in the stock markets and cooling off of the bond markets.

US DOLLAR INDEX

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I would like to close this week’s weekly, monthly and quarterly for that matter on this one last note. Even though interest rates took a rest this last week, they have been going up in full force since the beginning of May; and have been moving up steadily since July of last year. The USD index, although struggling, has been moving up since the March 2008 low. We are in a trend that if it keeps going could lock up the credit markets in a major way and bankrupt banks and governments all over the globe. The slowdown in China and the Commodity blocks is to me proof that the world is already deleveraging. Credit is present consumption of future production with interest. The future is here.

Now what does this mean for us traders? Well, it is becoming very apparent that the Fed is stuck in QE. But whether or not this means the dollar and interest rates will fall once they admit it is yet to be seen. The way the charts have been going, I am apt to say for now, that I don’t think the QE is working like central banks and governments want it too. I see both deflationary and inflationary pressures around the markets. However, deflation is winning so far and could come out wreaking havoc earlier then I thought. And I say this because it is what the charts are telling me. Next quarter, look for Dollar strength to continue, with the Euro and Pound contesting in a mostly risk off environment. And I would stay away from anything that is sensitive to yields unless I am shorting. Have a great week trading and talk to you next week.

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