Is the Uptrend in Dollar Going to Continue?

Since the begging of summer, the FX market volatility has calmed a bit with the EURUSD pair trying to find its direction for the next quarter. Last year the inflation expectation has been rising sharply as the USD dropped. However, it’s been a completely different story for 2021 as the dollar has been trying to erase those losses. 

The dollar index was falling starting from April and till the end of June which sent the index from 90 to 92.50. At the same time, the EURUSD pair dropped from 1.22 to 1.18, and the USDJPY pair rose from 108 to 111. The second half of the year could be even more interesting as the Fed is about to start tapering its monthly purchases. That is the consensus of market participants. The plan should be announced in August, and the actual taper is expected to begin in late 2021 or early 2022. 

There is some price tightening happening on the market with the Feds plan of hiking monetary policy in late 2022. However, it is far from being considered a “realistic expectation.”

As for the USD, the current resistance is at April highs of 93.50 (for the EURUSD pair, the support is at 1.17). If the dollar strengthens above that level, another leg higher could bring the dollar index to 95 and the EURUSD pair to 1.15. Alternatively, if the USD comes under selling pressure, the support for the index is at 90, and the resistance for the EURUSD pair nears 1.22.

Are US Stocks in Bubble Territory?

During the last few weeks, the S&P 500 and Nasdaq 100 indices have been pushing to new record highs, while the Dow Jones is lagging a bit. The S&P 500 index has not been this high in over the last 4 years. 

Historically, the market has only been more stretched than it is now, five times. And only once did stocks continue to rally by a lot – 36% at the height of the Tech Bubble in 1999. That’s when equities almost always correct 10%.

The chances are quite high that stocks will decline 10%. However, this time it may be different. It may be different due to the actions of the Federal Reserve (Fed) and other central banks that are pumping insane amounts of money into the markets each month. Additionally, between 1913 and 2020, the Fed never bought corporate bonds or corporate bond exchange-traded funds (ETFs). And yet, in 2020, the Fed did all of those things, and it continues to do so in 2021.

The current bullish momentum in stocks is powerful, and it would be unwise to start shorting the market because it is overextended and overbought. Stocks can rally another 5-15% without a problem, wiping the accounts of people who are short. 

For those who think that equity markets are in a bubble, it is better to wait for a reversal signal before executing short positions. Such a signal could be a bearish pin bar on daily/ weekly, a strong divergence between some indicators and the price, a double/ triple top pattern or just general exhaustion of the bull market when the price stops pushing to new highs. 

However, we haven’t seen such signals yet. Maybe there will be some positive changes in August at the Jackson Hole conference, where the Fed will announce its plans. Until then, the outlook remains bullish, and even though equities are in a giant bubble, it looks like the bubble will not burst anytime soon.

Are US Yields Resuming their Decline?

After the Consumer Price Index (CPI) jumped above 5%, multiple signals that inflation is running hot (lumber, copper, oil, and other commodities), the housing market entering a bubble, and stocks soaring to new all-time highs have finally pushed the Federal Reserve (Fed) to think and most importantly do something about tightening monetary policy. 

According to its announcement, the Fed is intending to start tapering Quantitative Easing (QE) in late 2021/early 2022 while also potentially raising rates late in 2022/ early 2023. However, no one can tell if it’s really happening any time soon. But the message was clear – investors should not expect the current monetary policy to last forever.  

Bond traders took it really seriously – bond prices rose quickly, sending yields sharply lower, suggesting the market now believes the Fed will tighten monetary policy and inflation will return to 2% soon. 

Looking at the long-term chart for yields on the 30-year US Treasury and it is clear that they failed to break their 35+ year downtrend. If the downtrend persists, it might be another bullish signal for US stocks as equities generally rise when yields fall.

Considering both the SP500 and Nasdaq 100 indices remain in their long-term uptrend channels, we could see a quick 10-15% summer rally toward their upper channel lines. Additionally, the USD remains weak, and it looks like it won’t maintain the bullish momentum it started after the Federal Open Market Committee (FOMC) decision. 

Despite the Fed being hawkish, it appears the long-term trends in the financial markets will remain intact, meaning stocks are expected to go up, bond yields down, and the USD sideways or lower.

Oil Rallies Amid Iran News

It seems like the oil is in a very good position on the market these days, since its price keeps on rising. This Monday it shown a nearly 3% gain. Following Iran’s presidential election, which was won by the ultraconservative judiciary chief Ebrahim Raisi, Iranian negotiators in Vienna, confirmed that they plan to continue pressing towards a deal.

“We have reached a clear text on all the issues, and what remains requires the decision of all parties. Therefore, it’s not unlikely that the next round of talks will be the last,” the foreign ministry optimistically stated.

In case of a successful nuclear deal, it would most likely lead to at least 2.5 million barrels of Iranian crude per day flooding back into the market. This would most likely result in oil price falling to increased supply, but traders have been buying any dip in oil so far. 

The Brent benchmark rose above 75 USD first time since October 2018 and at the same time, oil keeps on surging. The predictions of the Citigroup state that Brent will touch 85 USD before Q4 2021. But the Bank of America thinks it will go even higher, and its analyst Francisco Blanc reckons the commodity will reach triple digits or 100+ USD in 2022 as travel demand rebounds. 

From a technical point of view, Brent is now facing a stronger resistance of 75 USD, and if bulls push the price above that level, a further rally toward 80 USD could occur. On the downside, as long as oil remains above 70 USD, the medium and long-term outlooks seem bullish, with the short-term support probably located near 72 USD.

Equities Near Record Highs, But Risks of Volatility Mount

As the Dow Jones and SP500 indices getting close to their all-time highs, while the Nasdaq 100 index is slightly lower than its all-time highs, the US stocks have been very calm over the previous weeks.

It wasn’t that hard to predict this kind of dynamic since equities are perfectly correlated to the Federal Reserve’s (Fed) balance sheet. Thus, should the Fed continue in its current monetary policy, stocks will most likely continue posting new all-time highs every month.

But still, traders can benefit from this short-term volatility. According to the VIX (volatility index), some downside risks for stocks are rising. The VIX has compressed into a tightening pattern (a falling wedge pattern) that implies an end is coming to the low volatility regime in stocks. 

And then there is this correlation when the VIX rises the sticks will probably go down and vice versa. So, if the VIX breaks to the upside from its large pattern, volatility could return to equity markets. 

The first stronger support for the SP500 index seems to be at around 4,200 USD. If that is broken, further losses toward 4,120 USD could occur. The index needs to stay above 4,000 USD to maintain the medium-term uptrend. However, bulls should try to create – and hold – new highs soon, or there might some frustration among the bullish camp and profit-taking, dragging stocks lower.

Again, it’s worth mentioning that any decline and uptrend can be a buying opportunity, especially with the Fed that does not plan on changing its monetary policy any time soon. 

The Fed raising rates as the inflation running hot?

The manufacturing sector has been highly pressured by the recent inflation created by the high commodities prices, when most industrial and grain commodities have moved vertically.

As the Chicago Business Barometer states, the factory gate prices just hit a 41-year high. In other words, the last time inflation was this high in 1980. That happened when the Federal Reserve (Fed) was forced to raise rates to over 15% and was one of the worst inflationary storms in history.

Slowing manufacturing, rising prices

So back in March 1983 the ISM Manufacturing was at its highest, but there was still hope for a small improvement for the April. Despite these hopeful expectations the ISM dropped from 64.7 to 60.7 – even as prices paid increased further. The prices paid subindex – i.e, the inflation component – rose for the eleventh month and now stands at June 2008 levels. Back then oil was way above 120 USD, nearing its peak, while the US 10-year yield stood at 4. 

As manufacturers and suppliers face significant price pressures 0%, we can expect the retail prices of the goods in the Consumer Price Index (CPI) basket to rise over the next few months. This may result in the inflation way above 3%. Based on this, the investors would assume that strong price pressures should lead the Fed to tighten monetary policy.

Will the Fed raise rates?

When the central bank raises rates usually it is a bad sign for small companies with weaker balance sheets. Basically, they will need to pay more to survive in business. However, the largest companies may also be affected in case the rate goes up again. As bond prices drop, bond yields will surge, destroying bond investors. This situation has been happening since the summer of 2020. The economic activity usually contracts or slows down notably in the high-yield environment. It is expected that higher rates may lead to disinflationary pressures, but like with everything, it will take some considerable time for the real impact to show up. 

With all the mentioned facts we can conclude that the Fed can’t raise rates and can’t taper its Quantitative Easing (QE) program. Otherwise, it could lead to a significant correction in the stock markets and the slowdown of an already fragile economy. And unfortunately, this might not end well, as the Fed simply doesn’t see a way around this situation and is trapped in it.

Inflation Rages and US Dollar Collapse

The US dollar index has been dropping lately, and now it is facing the strong support level of 89.60 again. There are all chances that this level will continue dropping and will decline the critical support of 89.20. The last possible level of defense below that is somewhere around 88.40 and it is like the lowest it can fall. If it goes even lower, then we will be back to the 2012-2013 when the support level was 84 with a possible decline of 5%.

This situation would probably result in the EURUSD dropping to 1.40 and the USDJPY back below 100. The main reasons for such a drastic dollar drop are never-ending massive money printing, and high inflation which is a result of never-ending massive money printing. 

Commodities Sky Rocketing

Corn, soybeans, and wheat rose to multi-year highs, with corn having risen from around 3.80 USD per bushel in January 2020 to 6.75 USD now. Chicken wings are at record highs. 

The sky prices have been noticed in copper price, which is the highest of all times, also, steel recently traded at prices 35% above the previous all-time highs set in 2008. Additionally, the price of lumber has nearly quadrupled since the beginning of 2020 and has nearly doubled just since January. Silver has increased more than twice its price since COVID lows. West Texas Intermediate (WTI) oil is up from 0 last April to 67 USD today. 

While commodity prices increasing, prices of manufactured goods are rising fast too. The median price of existing homes in the US rose to 329,100 USD in March—a stunning 17.2% increase from a year earlier. Finally, the average used car price has risen 16.7%, and new car prices have risen 9.6% since January.

The Fed Remains Dovish

According to the Federal Reserve (Fed), the current inflation is transitory and that they have it under control. But considering all the facts that were mentioned above, investors don’t seem to agree. 

The uncertainty is hitting the US dollar. Should this inflationary environment continue, the Fed and the US government really risk the EURUSD rising to 1.40, most likely sending other assets higher up as everything is traded in US dollars. 

Alternatively, if the Fed starts to tighten monetary policy, the USD might defend the mentioned supports and potentially jump above 90 again. But since the Fed has said many times, it is not ready to think of tightening. The most likely scenario continues to be that the greenback will continue falling.

China Begins Taking Action Against Rising Commodities

The decision of China’s state planners to wage a war against soaring commodity prices has directly affected iron ore futures that fell sharply on Monday. China has threatened top metal firms with severe punishment for price manipulation, excessive speculation, and spreading fake news, according to Bloomberg. There’s a “zero tolerance” for monopoly behavior and hoarding, the National Development and Reform Commission (NDRC) told top executives of top metals producers on Sunday.

According to Bloomberg data, Chinese steel output in April increased to 97.8 tons last week, hitting monthly and daily run-rate records. And compared to the last year, the surge in production has increased year-to-date production to 375 million tons, which is 16% higher. 

Chinese Data Weakens

In addition to that, this Monday we saw the latest of China’s economic data for April, which disappointed and included a large retail sales miss with a print of +17.7% YoY (vs. +25% YoY expected). There were also misses for industrial output (at +9.8% YoY vs. +10% YoY expected) and YTD fixed investment (+19.9% YoY vs. +20% YoY expected).

However, the weakness in iron ore didn’t affect other commodities as oil flew 4% higher toward the current cycle highs near 66 USD, while precious metals were also trading higher. At the same time copper is dropping down 8% from its cycle highs reached earlier in the month. 

Lumber is Volatile 

As to the lumber, it has experienced a 30% correction in May but has managed to erase more than 50% of it, and therefore the long-term trend is high and as stable as it can be. Lumber is up more than 500% since its March 2020 lows. Since lumber is one of the key industrial commodities it can be targeted by central planners.

It looks like the ultra-lose monetary policies, never-ending money printing, and fiscal stimulus across the globe have pushed hard assets, such as commodities, sharply higher. Furthermore, the upcoming boom from reopening economies also helped in pushing prices higher. 

It’s hard to say if a deflationary crash ahead of us, but as long as central banks continue pumping money, commodities should outperform other assets. 

Are Stocks Headed for a Large Correction?

Even though equity indices continue to be bought in lower prices, the nearest future still doesn’t look bright. 

The most important bond in the world US 10 Year Treasury has been in an obvious downtrend for 40 years. However, for the second time since 2018, the 10-year yield is breaking out from this downtrend and will possibly lead to higher yields over the next months. The yield on this bond represents the “risk-free” rate of return for the entire financial system. This is the level against which all risk assets – stocks, commodities, real estate, etc. – are priced and discounted. 

US 10 Year treasury yield broke out from downtrend and started going up in 2018. And it successfully managed to rise above the 3% threshold. It caused a quick decline in risk assets and resulted in a dramatic drop of the US equity indices circa 20% in just a few weeks. 

Then and now

However, what happened in 2018 and what is happening now are two different things. Back in 2018 the Fed was raising rates and shrinking its balance sheet – selling bonds it had bought in Quantitative Easing (QE) programs before 2018. And what is happening right now is that the Fed fund rate is at zero. The Fed has pledged not to raise rates for two years, and the central bank is growing its balance sheet by 125 billion USD per month with QE.

Back then, the Fed stepped in and stopped the balance sheet reduction. It is not clear how it will turn this time. 

High inflation and upcoming tightening

The core inflation is rising to 3%, which is the fastest pace of price growth since 1982. In addition to this, inflation is running lose. The Fed needs to start raising rates and taper its QE program soon to control rampaging inflation. 

Market participants expect the central bank to announce plans to taper QE in September, while the actual process is forecast to start in Spring 2022.

It already looks like both Nasdaq 100 index and Bitcoin are forming a large topping pattern. That’s because tech companies are easily affected by the higher yields and not in a positive way. 

It seems like all the stock markets became too expensive and due for a correction. And therefore 2018 may repeat itself if the Fed decides to tight monetary policy, which will result in equities blowback. Only this time, stocks are much more overvalued, inflation is higher, and the economic situation is much worse. 

Until then, the long-term trend might continue with investors buying declines. But as we said, it all depends on the Fed and how long it will take to start the tightening cycle. 

Inflation is rising, commodities go vertical

The whole financial world is watching how the current inflation is rising at a fast pace. While some asset prices such as food, real estate and used cars are in upward trend, the commodities have gone vertical and expected to stay this way for a long period of time now. 

Causes of the Current Inflationary Environment

One of the causes is the amount of the printed money by the Fed in the US. The Federal Reserve (Fed) has printed more 3 trillion USD between March and June 2020. But the US Federal Government has printed upwards of 5 trillion USD via its stimulus programs. 

Also, President Administration has plans on spending another 2.25 trillion USD on infrastructure, 2 trillion USD on climate change, 1.8 trillion USD for American Families Plan and more. We can include other major central banks, and the amount of printed money would most likely double or triple.

Massive Rally in all Commodities

There are some crazy changes in the commodiries market too. On Monday, iron ore futures surged 10% to a record high, steel prices rose 6%, and copper prices touched record highs. Silver and gold are starting to pick up as well, with gold rising to 1,840 USD and silver attacking the 28 USD level. Oil went up rising from 0-10 USD to the current 65 USD, which is hundreds of percent over the last year.

Each month main equity benchmarks are rising to new highs that we haven’t seen before, and most of the cryptocurrencies are off the charts. Many market specialists are calling this the biggest bubble of all time. Every bubble has a speculative mania part and a leverage component: everyone thinks that gains are inevitable. It would be irrational not to borrow money and leverage to extremes to maximize the guaranteed profits.

Is this Going to Stop?

Doesn’t seem like it. With the current monetary policies that the Fed and other central banks would refise to quit, fueling the bubbles to even greater extremes. 

Commodities will continue to spiral higher, sending inflation further through the roof, effectively crushing the middle and low-income class. Ordinary people will be among the most significant losers during high inflation periods – all groceries, utilities, services, cars, products, day-to-day stuff will become more expensive, while wages won’t react as fast.