Category: Industry

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.

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.

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 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.

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. 

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.