Market Quick Take - June 18, 2021

What is our trading focus?

Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I) – the broader posted a mildly positive session, while the Nasdaq 100 rallied steeply to close at an all-time high on long US treasury yields backing off sharply, a boost to long duration assets like growth stocks. Elsewhere in the market, value stocks came under heavy pressure on the same driver, an interesting sign of turmoil in market breadth. Interesting to see how this shakes out as we have “quadruple witching” of financial futures today (discussed below).

Bitcoin (BITCOIN_XBTE:xome) and Ethereum (ETHEREUM_XBTE:xome). Bitcoin continues to settle back in the range below the key 40-42k area, trading near 38k this morning, with the recent weakness possibly on the sense that the US Fed is regaining some credibility on taking inflation seriously after the most recent FOMC meeting. Ethereum is struggling, meanwhile, and is now perched close to the pivot low near 2,260, which is the lowest level in almost a month.

USD pairs – the USD is very strong here as the market reprices Fed expectations after the Wednesday FOMC meeting this week. Together with the strong JPY noted below, it is the primary focus in FX right here, as EURUSD has become fully unglued and closed yesterday below a key retracement level that suggests a possible run to the interesting 1.1750 area, a kind of “head-and-shoulders" neckline, AUDUSD has broken below major support around 0.7550, etc. The move looks incredibly sharp and may be overdone very short term, but would take a huge countermove now to shift expectations of more USD strength.

JPY –the interesting sharp rally at the long end of the US yield curve yesterday despite the market continuing to sustain the reaction to the FOMC meeting at the short end of that yield curve helped power dramatic support for the JPY yesterday, with even USDJPY falling sharply on the day, but given the still-strong US dollar, the action in other JPY pairs was the most significant in months, with CHFJPY; EURJPY and AUDJPY worth a look for those looking for this move to extend, provided long US treasury yields remain anchored. The sell-off in commodities is also JPY-supportive.

Gold (XAUUSD) and silver (XAGUSD) are looking for support following a week of heavy losses triggered by an aggressive Federal Reserve causing the market to price lower the prospect for future inflation. Ten-year breakeven yields trade down 25 bp on the week thereby forcing real yields higher. Having sliced through several key support levels, gold is currently looking for support at $1769, a level that represents a 61.8% correction of the April to June rally. The road back to relative safety is currently quite long with focus on $1825 followed by $1,838, the 200-day moving average. Silver meanwhile has bounced ahead of key support in the $25.68-73 area.

US Treasury yields will continue to trade rangebound between 1.5% and 1.7% until the Federal Reserve won’t be actively engaging in tapering talks (TLT, IEF). Ten-year US Treasury yields dropped from their 1.59% high down to around 1.5%. The move has been caused by the market believing that inflationary and tapering fears were ahead of themselves after the FOMC meeting. Yet, the 5-year TIPS auction attracted an unexpected high level of demand showing inflation remains a concern. Foreign bidders demand rose to a record high of 87.3% and 5-year TIPS priced at –1.416% in yield. The results caused 10-year nominal years to stabilize above 1.5% after they dipped below this level. Also, to compress yields remains the extraordinary liquidity in money markets. Yesterday, the Fed’s RRP facility attracted demand for $756bn. These forces will remain into play until the Fed won’t engage actively in tapering talks.

Gilt yields are leading losses as the markets is increasingly more concerned about inflation in the UK (IGLT). Inflationary pressures in the UK will be stronger than elsewhere as Brexit act as a multiplier. Brexit is increasing problems concerning transportation and the labor market that may accelerate inflationary pressures in the country. This factor has been widely ignored by the market until now, but the CPI surprise and the Federal Reserve's meeting on Wednesday forced investors to revisit their strategy. We expect Gilt yields to continue to rise, and the Bank of England’s meeting next week has the potential to drive them higher to test their resistance at 0.85% if the message delivered is hawkish. If they break above this level, they will find resistance next at 1%.

What is going on?

The commodity sector is heading for its biggest weekly loss since the start of the pandemic with all sectors, led by grains and precious metals trading lower. Recent darlings like corn, copper, gold and even fortress crude oil all got dumped after the FOMC signaled it would speed up its expected pace of policy tightening. Inflation expectations as seen through 10-year breakeven rates dropped by 25 basis points while the dollar strengthened. Adding to these continued efforts by the Chinese authorities to reduce inflation through commodity market intervention. Yesterday’s grain market drop was the worst since 2009 with easing supply worries triggering a speculative exodus.

Japan CPI rises, Bank of Japan keeps its policy mix steady but announced an extension of the deadlines for existing programmes and a new plan for funding the fight against climate change that it will launch before year-end. In separate news, one of Japan’s CPI measures rose into positive territory for the first time since before the pandemic as the May CPI ex Food and Energy notched a +0.1% gain year-on-year versus no change expected. The headline CPI was –0.1% YoY vs. -0.2% expected, a remarkable contrast with the inflation spike in the US.

What are we watching next?

Quadruple “witching” and end of month/quarter. Today, futures and options on financial instruments (stocks, stock indices and treasuries and other interest rates) expire, possibly explaining some of the two-way churning in the market in recent days on top of the reaction to the FOMC meeting. As well, the US Fed’s reverse repo facility spiked an incredible 45% in a single day to over $750 billion, possibly on the Fed hiking the interest rate on excess reserves by 5 basis points at this Wednesday’s meeting, but also as US banks are likely rushing to shrink their balance sheets into regulatory reporting ahead of quarter end at the end of this month, a pattern that was well established before the Covid pandemic saw rules related to that activity suspended before their reinstatement a few months ago.

Some macro bets have clearly gone wrong – does volatility spike? The reaction to the FOMC meeting this week has set in motion some clear reversals of recent developments as the US yield curve flattened sharply yesterday (the biggest such move after a long period of steepening and then rangebound behaviour in recent months), value stocks came under significant pressure, commodities were likewise under pressure, and the USD and now even JPY are backing up sharply against commodity currencies, the euro and EM currencies. This could raise the risk of more near-term volatility as these trades have become significant consensus bets on the outlook as we emerge from the pandemic.

Economic Calendar Highlights for today (times GMT)

• 0830 – UK BoE Inflation expectations survey

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