Ring them bells for the blind and the deaf,
Ring them bells for all of us who are left,
Ring them bells for the chosen few
Who will judge the many when the game is through.
Ring them bells, for the time that flies,
For the child that cries
When innocence dies. – Bob Dylan
Cover by Sarah Jarosz:
The Fed is ringing bells, ever more loudly because the market is not listening. Two weeks ago I outlined the interesting comments regarding complacency that were released as part of the Fed minutes. Markets promptly completely ignored these cautionary words and rallied on to new highs with the $VIX sagging into the 11s. Predictably perma bulls are now busy outlining why a $VIX below 12 is supposedly bullish, but the Fed seems rather unhappy with the market’s response.
There are no accidents in a crafted communications strategy. So yesterday’s out of the blue headline article release by the Wall Street Journal’s in-house Fed organ Jon Hilsenrath re-emphasizing the very subject again was a clear signal that the Fed wants to make sure the message is clearly communicated. The fact that the same paywall article was additionally released on Marketwatch within minutes of the WSJ article highlights that they wanted this message wildly distributed. What’s the core message?
The worry at the Fed is that when investors become unafraid of risk, they start taking more of it, which could lead to trouble down the road. One example of increased risk taking: Issuance of low-rated U.S. dollar-denominated junk bonds last year hit a record $366 billion, more than twice the level reached in the years before the 2008 financial crisis, according to financial-data provider Dealogic.
“This indicates a great deal of complacency,” Richard Fisher, president of the Federal Reserve Bank of Dallas, said in an interview. “When you get complacency you’re bound to be surprised at some point.”
This message has now been pushed a few times these past few weeks. Here is Dudley on May 20:
On the subject of market volatility, Dudley said volatility in the financial markets is “unusually low,” returning to levels last seen in 2006-2007.
“That makes me a little nervous because I have to believe that even if most people in the room have something close to my view of the economy, there’s always the possibility of big surprises,” he said.
“So I’m a little bit nervous that people are taking too much comfort from this low volatility period and as a consequence of that they will take more risk than really what’s appropriate,” Dudley added.
So what’s going on? That’s subject to interpretation, but in my view something is rustling in the bushes and the Fed knows it. The simplest explanation would be that they realize that the market is way too hot and they want to talk it down a bit. So far unsuccessfully, but they surely don’t want a crash on their hands now. The basic truth remains this: When they QE’d asset prices to the moon they expected organic growth to occur, it didn’t, instead the top 1% grabbed almost all of the wealth expansion. In the meantime housing prices were inflated via speculators driving up prices paying cash via easy money policies and now we have a situation where half of Americans can’t afford to live in the place they’re in. Congratulations.
And now the Fed is stuck:
Fed officials face a double-edged sword. Officials want to keep interest rates low to boost economic growth and hiring and to lift inflation from levels below its 2% target. But, having been burned by the 2008 financial crisis, they are on the lookout for signs that the policies are having dangerous side-effects in financial markets.
“It is a problem of their own making. They can’t have it both ways,” said Martin Barnes, chief economist at BCA Research, an investment-advisory firm. “If they want to sustain zero interest rates and push up asset prices, how can they expect to have that with no excesses and no risk taking?”
And that’s the dilemma, they have created a monster and they don’t know how to tame it. Swell. Nobody, I repeat, nobody knows how this will unfold, but it’s dangerous as hell and the Fed knows it, yet too many people are still in dreamland in the mistaken belief that the Fed will keep saving every dip from turning into something worse. The banks want higher trading revenues, the Fed wants a less hot and complacent market, so the interests are aligning and given this backdrop my take is we will see these goals met.
While indices keep the flow on the surface selling continues under the surface. Our hanging man is still in effect and $NYMO is moving negative while volume keeps dropping:
Overnight we saw a quick dip in the #DAX and I exited half my position for a nice profit. I can’t predict what Draghi will or will not do tomorrow so I’m trying to block and tackle around my positions and #DAX provided for a nice opportunity to grab some profit on the tag of the lower trend line:
Can Draghi crank it above 10,000? Sure. Let him. I would add back in on a Draghi spike. If Draghi drops the ball I’ll keep the remaining position on.
Yesterday we also saw a very aggressive continuation of the bounce in yields. I closed my remainder position for a nice profit and have thus generated quite a bit of cash as the $TY short constituted an 8% exposure in my portfolio. Will markets ever drop? I hear this question in the comments I see all around. People are ringing their hands at a market that always comes back, never drops and just ascents every day. The latest levitation example: Financials.
The result: Completely overbought conditions. The last run of such singular direction occurred in early February which resulted in a quick drop to the middle Bollinger band. That is my short term target here. What will happen thereafter I suspect will largely depend on the $RUT. While it got saved again at the 200MA yesterday the confluence of negative MA action in this area, including a coming cross over of the 50MA over the 200MA, does not make for a bullish outlook:
So the game continues, but bulls are rapidly running out of time. After Draghi and NFP Friday I can’t see a bullish trigger of any sort. In fact seasonality is now heavily turning against any notion of further upside in the next few days:
I remain focused on my roadmap and while I can’t exclude the possibility of another ECB QE fueled spike higher I’m also not clear what joys the market would derive from the NFP number on Friday. A big beat will keep taper on, a big miss I suppose would be ignored as any miss has been. For that reason it might be prudent to grab some calls as a hedge on weakness today. As I have raised some solid cash from $TY and $DAX sales I remain flexible to add if need be. For now I simply stick to my $SPX roadmap. The 5 EMA continues to keep a lid on the downside and we have to watch it for further guidance: