Scrooge Rules

It was a difficult week for investors. Our anticipation of a Santa Claus rally at the end of November proved wide of the mark.  Instead, the MSCI World Index of developed markets is off around 9% this month with a three-week decline in tow.  Emerging markets have fared a bit better.  The MSCI Emerging Markets Index has also fallen for three consecutive weeks but is off about 3.5% on this leg.  Yields fell earlier in the month, but this past week was more mixed.  The benchmark 10-year yields rose in both the UK and Japan.  They were off a single basis point in Germany, while the deal with the EU helped Italian bonds rally with the yield falling nearly 20 bp.  The US 10-year yield eased 5 bp to slip below 2.80%, while the two-year yield eased nearly three basis points to 2.66%, despite the 25 bp hike in the Fed funds target range (to 2.25%-2.50%) and anticipation of two more increases in 2019 and one in 2020.   Supply and demand concerns saw WTI for February delivery dropped 10.5% to almost $45 a barrel,.  Gold rose a little more than 1.5% to $1264, a five-month high.  The dollar was mixed last week but ended on a firm note.  It gained against the dollar-bloc currencies and the Norwegian krone but lost ground against the other European currencies and yen.  

Dollar Index:  The Dollar Index lost about 0.5% last week, giving back about half its gains from the previous week.  It has been in a clear 96.00-97.50 trading range since the end of October.  There have been some intraday breaks higher, yet the Dollar Index closed above 97.50 only once this year (November 12).  The five-day moving average has slipped below the 20-day moving average, but the range trading has whipsawed these averages in recent weeks.  We anticipate further range trading.

Euro:  The euro was turned back after pushing toward the upper end of its two-week trading range.  It rose to about $1.1485, its best level since November 7 (and the 100-day moving average), a day after the Federal Reserve hiked its target range by 25 bp amid much controversy and claims that it risks a recession.  However, the pullback back ahead of the weekend saw the euro takeout support in the $1.1380-$1.1400 area, which helps neutralize the technical tone. With the US two-year premium over Germany still moving lower and is now at a three-month low (~325 bp), the downside is likely to be limited to the $1.13 area.      

Yen:  The dollar fell against the yen in the first four sessions of last week before eking out the smallest of gains ahead of the weekend.   The dollar lost a little more than 1.75% against the yen, the most in ten months.  The technical condition is stretched, but we suspect the decline will set into motion hedging activity that could see the greenback's losses extended.  A convincing break of JPY110.75 could spur losses toward JPY109.50.  Initial resistance has been found near JPY111.50, while a move above JPY112.00 is needed to stabilize the technical tone.  

Sterling:  Since the middle of November, sterling has been walking down the 20-day moving average, with bounces flirting with it, but unable to close above it.  In three sessions last week, sterling tested the average and was turned back, including the last two sessions. The 20-day average begins the new week near $1.2685. The technical indicators appear to favor the upside, but sterling struggles to sustain any upside momentum.  The thinning of market conditions takes some pressure off sterling, which will likely return in early 2019.  Against the euro, sterling fell for a fourth consecutive week, but momentum was faltered as the week drew to a close.  

Canadian Dollar:  The Canadian dollar fell to new lows for the year against the US dollar, and extended its losing streak to a fifth consecutive week.  The downside momentum accelerated.  The roughly 1.6% loss was the largest in nine months.  The drop in oil prices, ideas the Bank of Canada is pausing its rate cycle, some poor economic data (including the deterioration in senior loan officer survey before the weekend and soft CPI figures and less portfolio capital inflows), and risk-off sentiment were the main drivers.  As we have noted before, the US dollar has fallen in only one week here in Q4 against the Canadian dollar.  The technical indicators are stretched but not diverging from prices, and the greenback closed on the highs of the session near CAD1.36. The next major technical area is CAD1.37-CAD1.38.  Speculative positioning in the futures market is modestly the short Canadian dollar.  Although these speculators often are thought to lead the market, that does not seem to be the case now.  

Australian Dollar: The Australian dollar has a three-day and a three-week run of losses to start the new week.  It lost nearly 1.7% to put it at its lowest level since the start of November.   Here too the technical indicators are stretched, but without divergence or a reversal pattern, there is little to encourage bottom-pickers.  The low set in October (~$0.7020) was not seen since February 2016, and it is set to be retested.  There is a double top from Q3 17 and Q1 18 (~$0.8150), and it projects to about $0.6850-$0.6900.   Although the central bank insists that the next move is likely to be a hike, we suspect it will be a cut (late next year or early 2020).    Speculators have been reducing their net short Australian dollar futures position, but it is roughly four times larger than the net speculative short in the Canadian dollar futures. Speculators have not had a net long Aussie position in the futures market since last April. 

Mexican Peso: The Bank of Mexico had no qualms about raising interests the day after the Fed did even though at 3.25%, the target rate adjusted for inflation is the highest in the OECD.  Its stock market is near two-year lows.  No one cries that it is a policy mistake as they have in the US. The peso was rewarded and bid to six-week highs.   The dollar found support in the MXN19.80-MXN19.85 area.  Recalling that the dollar was testing MXN20.50 a week ago, it is understandable why the technical indicators are stretched. The high yield and stable currency may attract flows into the short-end of the Mexican debt market as a place to park funds over the holiday period.  

Oil:  February 2019 WTI fell to almost $45 a barrel ahead of the week, which put it down around 12% for the week.  A four-year high was recorded in early October near $76.40.  Supply concerns were dominant.  The energy revolution in the US is well known, driven by technological innovation, access to cheap credit, and an attitude toward the environment that is not universally shared. Russia's output cuts appear to be coming after it increases production.  Businesses with high fixed costs are often incentivized to keep producing even if the price falls below the cost of production.  Many economists who warned us a year ago about 2018 being a synchronized upturn and were looking in their rearview mirror, now say 2019 will be a  synchronized downturn.  There is chart support near $45, but a break would target $40.  The low from 2016 on a continuation chart is near $26 a barrel.  

US Yields: Since closing November 1 near 3.22%, the yield on the US 10-year Treasury has tumbled to 2.75% last week before returning to the 2.80% area ahead of the weekend.  The business press is playing up the narrative that the markets are warning of a policy mistake leading the US into a recession.  Neither the economic data nor economists' forecasts suggest the US is on the verge of a contraction.  Talk of a 40% chance of a recession is based on various models of market prices and do not offer an independent assessment/verification.  We continue to emphasize other considerations, like the nearly third increase to around $7 trillion of negative yielding bonds this quarter, the concentration of new supply at the short-end of the US curve.  The technical indicators on the 10-year futures note are stretched. Be on the lookout for a reversal pattern.  Separately, note that the January 2020 Fed funds futures contract implies that the effective average rate at the end of next year will be 2.51%.  After last week's rate hike and a smaller increase in the interest on reserves, the average rate quickly jumped to 2.40%.  That is consistent with about 50% of a single hike being discounted.  

S&P 500:  The stock market could not get out of its own way.  It finished the week on its lows, some 6.4% lower than where it began.  It is off around 12% this month.  It has risen in only four weeks in Q4.  It has closed lower in five of the past six sessions and that session it rose, it increased by $0.22, or for those who insist on percent changes, 0.01%.  The market finished on its lows for the week, which was also the lows since September 2017.  The technical indicators are stretched. The S&P 500 along with the NASDAQ and Dow Industrials closed below their lower Bollinger Bands (two standard deviations from the 20-day moving average). Yet, given the approaching holidays, there may be a greater reluctance to buy than sell, suggesting the risk still lies on the downside.  A break of 2400 will be another blow to psychology.  If the bull market is over, then we should be prepared for a retracement of the big advance.  The 38.2% retracement objective, for example, is near 2075.    

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