Stocks are poised for a breakout, signaling a fresh advance on the S&P 500. All eyes are focused on the September 17-18 FOMC meeting, with an expected rate cut of at least 25 basis points.
Stocks
The S&P 500 is testing resistance at its previous high of 5670, while Trend Index troughs above zero indicate buying pressure. Breakout would offer a target of 6000.
The equal-weighted index ($IQX) has already broken resistance. Retracement respected support at 7000, confirming our target of 7400.
The Russell 2000 Small Caps ETF (IWM) lags, with the Trend Index struggling to recover above zero. A breakout above 225 would offer a target of 250.
Financial Markets
Liquidity in financial markets is gradually tightening, which could act as a handbrake on any advances. A contracting Fed balance sheet, net of TGA and reverse repo (RRP) liabilities, shows the effect of regular monthly QT reductions.
Commercial bank reserves are shrinking as a result.
Bitcoin struggles to hold above support at $60K, highlighting the effects of tightening liquidity.
Treasury Markets
Ten-year Treasury yields are rallying to test resistance at 4.0%, but long-term buying pressure—signaled by Trend Index peaks below zero—is expected to keep yields low for the next quarter.
Bank of Japan
A wild card that could disrupt the system is BOJ monetary policy. The last rate hike, to 0.25%, caused the Dollar to fall sharply against the Yen and a sell-off in US financial markets as carry trade positions were unwound.
Further rate hikes are on the cards, with the next BOJ meeting scheduled in October. Jim Grant from Grant’s Interest Rate Observer:
CPI excluding fresh food in Japan’s capital grew at a 2.4% annual pace in August, data released yesterday show, topping the 2.2% consensus expectation and marking its fourth consecutive sequential increase. That data series typically serves as a leading indicator for broader price pressures in the world’s fourth-largest economy; nationwide CPI data is due on Sept. 19.
Pointing to transitory factors including expiring government subsidies for utility bills and rice shortages, Norinchukin Research Institute chief economist Takeshi Minami predicted to Reuters that “the underlying inflation trend will continue to moderate in coming months.”
However, percolating wage growth – with average pay rising 5.2% this year per data compiled by Japanese Trade Union Confederation, the highest in more than three decades – could bolster the Bank of Japan’s appetite for further tightening following the July 31 rate increase to 0.25% from a 0% to 0.1% range, as BoJ chief Kazuo Ueda suggested to parliament last week.
Considering the acute financial spasm which followed that rate adjustment and accompanying unwind of yen-funded carry trade positions, the prospect of a sequel would presumably be front of mind for Mr. Market. Investors remain confident that such an outcome is in fact far-fetched, with interest rate futures assigning only 9% odds of further tightening at the BoJ’s Oct. 18 meeting.
Some observers aren’t so sure. “My money is on another rate hike in October,” Moody’s senior economist Stefan Angrick told CNBC Friday, further predicting at least one further uptick early next year. Bloomberg economist Taro Kimura likewise anticipates an October shift to 0.5%, writing that Thursday’s data illustrate “a broad upswing in service prices,” and “increases the risk that the BoJ can’t afford to wait to pare stimulus.”
The destabilizing effect of further BOJ rate hikes should not be underestimated.
Inflation
US inflation, on the other hand, remains subdued. Core PCE inflation ticked to 2.6% for the 12 months to July, but the Trimmed Mean PCE rate declined to 2.7%.
Monthly core PCE and the headline rate for July are more encouraging, with both growing at an annualized rate below 2.0%.
Dollar & Gold
The Dollar Index remains in a strong downtrend, with Trends Index peaks below zero, warning of long-term selling pressure. We expect the latest rally to encounter resistance at 102.50.
Gold retraced to $2,500 per ounce, with a likely test of support at $2,475 as long-term Treasury yields rally and the Dollar strengthens. However, the precious metal is in a strong up-trend, and respect of support would confirm our target of $2,600.
Silver is weaker than gold because of weak industrial demand from China’s solar industry. A breach of its current support level near $29 per ounce would warn of a decline to test long-term support at $26.50.
Crude Oil
Brent crude continues to build a base between $76 and $82 per barrel. Low crude prices ease inflationary pressures in the global economy and improve the prospect of lower interest rates.
Base Metals
Copper penetrated its descending trendline, suggesting that a base is forming. A correction that respects support at $8,600 per tonne would strengthen the signal.
Aluminum rallied strongly, indicating improving industrial demand. A breakout above $2,500 per tonne would be a bullish sign for copper.
Conclusion
Financial markets warn of gradual tightening, but low long-term interest rates, subdued inflation, and the prospect of a Fed rate cut at the FOMC meeting on September 17-18 are all bullish for stocks. We expect the S&P 500 to break through resistance at its previous high of 5670, confirming our target of 6000.
However, investors need to be aware of the risks ahead in 2025.
After the November elections, Treasury is expected to shift its quarterly funding towards longer-term coupons to take advantage of lower yields. The resulting increase in supply could drive up long-term yields while reducing liquidity in financial markets. On the other side of the Pacific, further rate rises by the Bank of Japan could spark a sell-off in US financial markets as more Yen-financed carry trades are unwound.
Either of the above actions could contract liquidity in financial markets, causing another stock sell-off.
We remain bullish on gold as long as long-term interest rates remain low, weakening the Dollar. Silver is likely to underperform due to weak industrial demand.
Acknowledgments
- CoinDesk: Bitcoin Prices
- Grant’s Interest Rate Observer: Tokyo Drift