Category: Fixed Income

Treasury, municipal and corporate bonds

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How the SRF could blow up the Treasury market

Key Points

  • The Fed’s Standing Repo Facility (SRF) is designed to provide backup funding to the repo market during periods of liquidity stress.
  • The $12 trillion repo market is secured by government securities, normally USTs, and has largely replaced unsecured interbank lending.
  • However, hedge funds are taking advantage of the SRF to finance highly leveraged basis trades.

Unsecured interbank lending has largely been replaced by repo financing after the breakdown of trust in the global financial crisis of 2008.

A repo is short for repurchase agreement, where the borrower sells government securities, typically US Treasuries, with an agreement to repurchase them at a slight discount the following day. The repo (discount) rate, formally known as the Secured Overnight Financing Rate (SOFR), has increased in importance as the repo market has grown to almost $12 trillion, overshadowing the widely known Fed Funds Rate (FFR). Both the SOFR and FFR are managed by the Fed through its open market operations.

A sharp spike in the repo rate in 2008 threatened to collapse the entire financial system. The Achilles heel of the banking system, and the reason for the Fed’s existence, is maturity mismatch. Borrowers take advantage of low interest rates in the short-term market and invest in long-term assets, capturing the wide spread. That works well until the yield curve inverts. Short-term rates spike upward as available credit contracts, causing a fire sale of long-term assets as borrowers scramble to raise cash to repay loans. A spike in the repo rate effectively serves as a margin call on long-term assets.

The first instance occurred during the 2008 subprime crisis, when the repo market ceased functioning, leading to a panicked sale of assets. Then, in 2019, repo rates spiked after the Fed’s QT had lowered bank reserves, reducing the supply of bank credit available to fund repos. The spike led to the famous Powell pivot, where the Fed abruptly ended QT and expanded its balance sheet (QE) to inject liquidity into financial markets.

Again in March 2020, repo rates spiked during the COVID pandemic, causing a sell-off of US Treasuries financed through highly leveraged basis trades.

The chart below shows the spread between the repo rate (SOFR) and the fed funds rate (FFR) in 2019 and 2020.

SOFR-FFR

The Fed responded by establishing the Standing Repo Facility (SRF), through which borrowers can obtain repo finance directly from the Fed when there is a shortage in the repo markets. The SRF acts as a market stabilizer, limiting increases in the SOFR and preventing a repeat of earlier repo market collapses. The underlying purpose is to avoid a fire sale of US Treasuries if the repo market ceases to function.

Hedge funds have increasingly tapped the repo market to finance highly-leveraged basis trades, which take advantage of the spread between repo rates and the implied discount on Treasury futures. The SRF has encouraged these trades by limiting the downside risk. Hedge funds pocket the spread when repo rates are low, and rely on the SRF to save them if rates rise.

We suspect that the size of leverage investment in US Treasuries is greater than commonly believed. Over the past decade, offshore investment in US Treasuries has swung from foreign central banks to private sector investment, primarily through offshore financial centers favored by hedge funds.

Basis trades are likely to continue growing as long as the Fed maintains a standing repo facility to stabilize the repo market. The SRF enables hedge funds to enter profitable leveraged trades on US Treasuries with limited downside risk.

As Charlie Munger said, “Show me the incentive and I’ll tell you the outcome.”

Stocks

The S&P 500 remains tentative after last week’s contraction in financial market liquidity.

S&P 500

A contraction in the ADP’s four-week moving average of private sector job creation to -11,250 has not helped.

ADP Private Sector Jobs - NER Pulse

Financial Markets

The secured overnight financing rate (SOFR) remains above the rate paid to banks on reserve balances (IORB), indicating financial market stress.

Secured Overnight Financing Rate (SOFR) & Interest on Reserve Balance (IORB)

Bitcoin is re-testing support at 100K, warning that liquidity remains tight.

Bitcoin (BTC)

Dollar & Gold

The dollar is weakening as prospects for a December rate cut improve.

Dollar Index

Silver rallied to test its previous high at $54 per ounce.

Spot Silver

Gold followed, with a rise to $4,230 per ounce. A breakout above the resistance level at $4,400 would offer a target of $5,000.

Spot Gold

Conclusion

Basis trades funded through repo markets are expanding as the Fed’s standing repo facility (SRF) enables hedge funds to profit with limited downside risk while the Fed acts as a backstop.

Basis trades increase the vulnerability of US Treasury markets as hedge funds are highly leveraged short-term holders of USTs. In the past, unwinding basis trades have caused a sharp rise in Treasury yields when repo rates spike. The SRF may prevent a repeat of past spikes but provides an incentive for hedge funds to take on greater risk, expanding the size of their basis trades and increasing Treasury market vulnerability.

Financial markets remain unsettled, with Bitcoin testing long-term support at 100K. Gold and silver rallied, and breakout to new highs would offer targets of $5,000 and $62 per ounce, respectively.

Acknowledgments

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Gold bear trap & the AI illusion

Key Points

  • Gold recovered above $4,100 per ounce, signaling another test of $4,400.
  • Silver similarly recovered above $50 per ounce.
  • Bitcoin at 106K indicates improving liquidity.
  • The S&P 500 also completed a bear trap, indicating another rally.
  • A recent Stanford study suggests that the adoption of generative AI has had a minimal impact on employment levels.

Gold recovered above $4,100 per ounce, completing a bear trap with a target of $4,400.

Spot Gold

Silver similarly recovered above $50 per ounce, offering a target of $54.

Spot Silver

Bitcoin, our real-time indicator of financial market liquidity, rallied to 106K. Respect of long-term support at 100K offers a target of 116K, indicating the liquidity squeeze is fading.

Bitcoin (BTC)

The S&P 500 completed a similar bear trap at 6750, suggesting a rally to test 7000. Follow-through above 6900 would confirm.

S&P 500

41 AI-related stocks dominate the market capitalization of the S&P 500. Investors have gone all-in on AI and its ability to generate future earnings.

S&P 500 AI-Related Stocks

Jonathan Levin argues in Bloomberg that, excluding the AI-related Tesla and Amazon, consumer-facing sectors of the S&P 500 are in recession.

S&P 500 Consumer Staples & Discretionary

A recent Stanford study on ChatGPT adoption indicates significant increases in productivity in fields with high adoption rates. However, it notes that the improved productivity has, so far, led to increased wage rates rather than reduced employment levels.

Treasury Markets

10-year Treasury yields are consolidating around 4.10%, with resumed BLS inflation readings likely to provide further direction.

10-Year Treasury Yield

Trump-appointee Fed Governor Stephen Miran on Monday repeated his call for a half-percentage-point cut at the FOMC December 9-10 meeting. (Reuters)

Consumer perceptions of long-term inflation remain elevated, with the University of Michigan survey indicating that perceptions of 5-year inflation have averaged 3.7% over the past three months.

University of Michigan: 5-Year Inflation Expectations

Dollar & Gold

The dollar has weakened following high private sector layoffs in October, with financial market pricing indicating a 63% chance of a 25-basis-point rate cut in December. (Reuters)

Dollar Index

JP Morgan estimates that the labor market added 52K jobs in September but lost 35K in October, increasing the likelihood of another rate cut in December.

JP Morgan Estimated Labor Market Growth

Conclusion

We expect further rate cuts to weaken the dollar and boost prices of gold and silver.

S&P 500 performance depends on projected AI productivity gains, driving a massive increase in earnings for AI-related corporations. However, there is currently limited evidence to support this conclusion.

Acknowledgments

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A government shutdown + declining consumer confidence

Key Points

  • The US government shut down most operations on Wednesday as Congress failed to reach a deal to raise the debt ceiling.
  • Government shutdowns do not usually have a lasting effect on financial markets, but the fiercely divided House threatens a bitter standoff.
  • Declining consumer confidence and further signs of a weakening labor market will likely contribute to a slowing economy.

The Conference Board’s measure of consumer confidence declined to 94.2, remaining at 2020 pandemic levels since a steep plunge in April 2025.

Conference Board: Consumer Confidence

Labor Market

Signs of a weakening jobs market are growing, with unemployment rising above job openings in August, for the first time since April 2021.

Job Openings

Temporary employment declined to 2.5 million. Low temporary hires indicate declining employer confidence in the economic outlook.

Temporary Employment

Declining average weekly hours worked warn of increased layoffs in the months ahead.

Average Weekly Hours

A low quit rate of 1.9% reflects declining employee confidence in the job market.

Quit Rate

Stocks

The S&P 500 continues to test resistance at 6700 despite concerns over the government shutdown. A breakout would offer a medium-term target of 6900.

S&P 500

Financial Markets

High-yield spreads remain at a low 7.5%, indicating credit is readily available in financial markets.

Junk Bond Spreads

Bitcoin is more tentative, having twice tested support at 110K. A breach of the support level would warn of a sharp contraction in financial market liquidity.

Bitcoin (BTC)

Treasury Markets

10-year Treasury yields will likely retest resistance at 4.2% in the next few days, driven by uncertainty from the government shutdown. A breakout above 4.2% would offer a medium-term target of 4.4%.

10-Year Treasury Yield

Dollar & Gold

The US Dollar Index retreated below support at 98, but the outlook for lower interest rates remains uncertain.

Dollar Index

Gold climbed to $3,868 per ounce, demand fueled by the increased uncertainty. A breakout above $3,900 would signal a test of our year-end target of $4,000.

Spot Gold

Silver ripped through our target of $45 per ounce, with rising Trend Index troughs signaling strong buying pressure. A breakout above resistance at $47 would offer a target of $50.

Spot Silver

Platinum has re-joined the party, with a breakout above $1,500 offering a target of $1,700.

Platinum

Conclusion

Uncertainty over the US government shutdown has boosted demand for precious metals. Resolving partisan differences over government funding and extending healthcare benefits will likely prove difficult.

Consumer confidence is low, and a weakening labor market warns of a slowing economy. An extended shutdown would further undermine spending, pushing the economy closer to a recession.

Strong financial market liquidity supports high stock prices, but a Bitcoin retreat below 110K would warn of a contraction that would hurt equity markets.

Acknowledgments

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Bond yields and the dollar fall as gold reaches a new high

Key Points

  • Long-term Treasury yields are falling steeply in anticipation of more Fed rate cuts as the economy slows.
  • The S&P 500 is retracing to test short-term support at 6500.
  • Financial market liquidity remains strong, supporting stocks.
  • The dollar is weakening, and gold and silver soared to new highs.

10-year Treasury yields fell to 4.046% testing the long-term band of support between 4.0% and 4.1%.

10-Year Treasury Yield

Expectations of steeper Fed rate cuts grow as more evidence emerges of a slowing economy. The Cass Freight Index is in a strong downtrend, and a fall below 1.0 would signal a recession. A useful barometer of economic activity, the index measures the number and cost of freight shipments across North America based on data from hundreds of large shippers.

Cass Freight Index

The current turmoil over tariffs — after the US Appeals court overruled Donald Trump’s “reciprocal” tariffs and his earlier “fentanyl” tariffs against China, Canada, and Mexico — will likely cause a sharp contraction in capital investment due to the uncertainty, almost guaranteeing a recession. Trump has lodged an appeal with the Supreme Court, but a decision is unlikely before next year. Unless he can get a stay on the lower court’s ruling, Treasury will be forced to fund the billions of dollars in tariffs collected.

While some believe that overturning the tariffs would cause a blowout in the fiscal deficit, we believe that the promise of a boost in revenue from tariffs was more spin than substance. There are no free lunches in economics; when something looks too good to be true, it usually is. Most of the cost of tariffs is currently borne by US corporations, but will likely be pushed onto consumers through price increases over the next year.

Goldman Sachs: Estimated Incidence of Tariff Costs

Where corporations do not pass on tariffs to customers, their profits and corporate tax paid to the Treasury will decline. Falling profits also hurt stock prices, reducing capital gains taxes. US consumers and corporations will directly or indirectly pay for the tariffs, and the impact on net Treasury receipts will likely be marginal.

Our biggest concern is not the loss of tax revenues, but the economic impact of policy uncertainty.

Stocks

The S&P 500 is retracing to test its latest support level at 6500, but rising Trend Index troughs indicate buying pressure, and respect of support will likely signal a further advance.

S&P 500

The equal-weighted S&P 500 ($IQX), more representative of large caps than the headline index, tests similar support at 7600. Rising Trend Index troughs again indicate buying support and likely continuation of the uptrend.

S&P 500 Equal-Weighted Index

Financial Markets

High-yield bond spreads are declining, indicating the return of loose financial conditions supporting high stock prices.

Junk Bond Spreads

Bitcoin (BTC) respected support at 110K, further indicating easing financial conditions — a bullish sign for stocks.

Bitcoin (BTC)

Dollar & Gold

The dollar is weakening in line with the outlook for interest rates. A US Dollar index breach of the long-term band of support between 96.5 and 97 would strengthen our long-term target of 90.

Dollar Index

Gold closed at a new high of $3,645 per ounce, while rising Trend Index troughs signal buying pressure. Expect a retracement to test support between $3,500 and $3,600, but respect will likely confirm an advance to $4,000 by the end of the year, as the dollar weakens.

Spot Gold

Silver is testing resistance at $41.50 per ounce. Again, we expect a retracement followed by a further advance, with a target of $44.

Spot Silver

Energy

Brent crude held steady at close to $66 per barrel after the OPEC+ meeting on the weekend decided on a smaller-than-expected initial increase in production of 137,000 barrels per day, in a phased unwinding of the 1.66 million barrels per day post-COVID production cut.

Brent Crude

Conclusion

Cyclical pressures are driving long-term yields lower, with a slowing economy likely to cause steeper-than-expected Fed rate cuts. Added uncertainty over tariffs increases the risk of a recession.

Loose financial conditions, boosted by falling Treasury yields, support stock prices, but a slowing economy would be bearish for earnings.

The dollar is weakening in response to the expected fall in interest rates, and a US Dollar Index breach of support between 96.5 and 97 would strengthen our long-term target of 90.

We expect gold and silver to rise as the dollar weakens, with respective targets of $4,000 and $44 per ounce by the end of the year.

 

Acknowledgments

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Weak labor report hammers stocks

Key Points

  • The S&P 500 and Dow fell sharply on the poor July jobs report
  • Financial markets warn of easy credit conditions, which could lead to markets mispricing risk
  • Real GDP growth is misleading due to the buildup of inventories in Q1, ahead of tariffs, and their subsequent rundown in Q2
  • Long-term Treasury yields fell, and the dollar weakened, anticipating lower interest rates
  • The fall boosted demand for gold

July payrolls increased by 73K, below the estimate of 104K, but big downward revisions to the previous two months spooked investors. A combined revision of -258K to May and June employment lowered job gains to 19K and 14K, respectively.

Employment Growth

Stocks were hammered, with the S&P 500 displaying a bearish engulfing on the weekly chart. Breach of support at 6200 would signal a correction to test 6000.

S&P 500

The Dow Jones Industrial Average failed to confirm the S&P 500 bull market signal and has now broken support at 44K, warning of a correction to 42 K.

Dow Jones Industrial Average

Financial Markets

The Chicago Fed National Financial Conditions Index warns of further easing with a fall to -0.57, signaling loose monetary conditions similar to 2021 during the COVID pandemic.

Chicago Fed National Financial Conditions Index

During the week, we highlighted the risk of a credit bubble if super-easy financial conditions persist:

Looser monetary policy would accelerate credit growth (light blue) above the nominal GDP rate (dark blue), leading to malinvestment as in the credit bubble preceding the 2008 global financial crisis. Mispricing risk feeds instability, leading to an inevitable collapse when assets reprice.

Bank Credit & Nominal GDP Growth

Bond market guru Jim Grant today confirmed the worrying speculative bonanza:

It’s a speculative-credit bonanza. Freewheeling conditions in the primary market pushed leveraged loan activity to new heights in July, with domestic new issuance reaching $223.2 billion. That’s the largest one-month total on record, comfortably topping the prior $206 billion peak established in January….

“I haven’t seen a market quite like this post the Great Financial Crisis,” Jon Poglitsch, managing director at Sycamore Tree Capital Partners, marveled to Bloomberg Wednesday. There’s a “grab for spread where anyone can find it,” he noted.

Loose financial conditions will likely be exacerbated if the Fed caves to political pressure and cuts interest rates, risking a credit bubble.

Treasury Markets

The weak jobs report swept aside concerns over the uptick in June core PCE inflation to 2.8%.

PCE & Core PCE

10-year Treasury yields plunged, anticipating Fed rate cuts, testing long-term support at 4.2%.

10-Year Treasury Yield

Economy

Real GDP growth recovered to an annualized rate of 2.9% in Q2, but the numbers are misleading. The biggest contributor was a sharp reduction in inventories after massive Q1 pre-orders, front-running the tariffs announced by President Trump in April. The contraction in Q2 aggregate hours worked reveals a far gloomier picture.

Real GDP & Total Hours Worked

A 50K July decline in employment in cyclical sectors — manufacturing, construction, transportation, and warehousing — warns that the economy is slowing.

Cyclical Employment

Labor Market

Job openings and unemployment remain in balance, as highlighted by Chair Powell at this week’s FOMC announcement.

Job Openings

Annual growth in average hourly earnings at 3.9% reflects reasonable labor demand.

Average Hourly Earnings

Dollar & Gold

The US Dollar Index fell sharply on the July jobs report, anticipating lower interest rates ahead.

Dollar Index

The fall boosted demand for gold, which is testing resistance at $3,360 per ounce. Breakout would signal a test of $3,440.

Spot Gold

Conclusion

A weak jobs report, with falling employment in cyclical sectors, warns that the economy is slowing. Stocks are expected to undergo a correction, with the S&P 500 testing support at 6000 and the Dow testing 42K.

Interest rates are expected to fall, with the Fed cutting rates to create a soft landing. Lower interest rate expectations have also weakened the dollar and boosted demand for gold.

Easy credit conditions increase the risk of a credit bubble, which could lead to investors mispricing risk.

We are underweight stocks except for defensive sectors, and overweight cash, gold, and short-term financial assets.

Acknowledgments

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S&P 500 weakens and gold rallies

Key Points

  • The S&P 500 closed above 6300 for the first time, supported by strong liquidity
  • But declining Trend Index peaks warn of a retracement
  • Consumer Confidence remains weak, and the Conference Board Leading Economic Index signals a recession
  • Gold and silver rallied as the dollar weakened

The S&P 500 closed above 6300 for the first time, but declining Trend Index peaks warn of selling pressure. Expect retracement to test support at 6100.

S&P 500

The Dow Jones Industrial Average also signals weakness, with declining Trend Index peaks indicating selling pressure.

Dow Jones Industrial Average

The Broad DJ US Index (red) has underperformed the DJ World ex-US index (blue) over the past six months.

DJ US Index ($DJUS) & DJ World ex-US ($W2DOW)

Financial Markets

Financial markets grow increasingly supportive, with the Chicago Fed National Financial Conditions Index (NFCI) declining to -0.54. Values above zero are considered restrictive.

Chicago Fed National Financial Conditions Index

Bitcoin has retraced slightly from resistance at $120K, but still signals bullish market conditions.

Bitcoin (BTC)

Treasury Markets

10-Year Treasury yields declined to 4.35%, but rising Trend Index troughs signal continued buying pressure.

10-Year Treasury Yield

Economy

Consumer confidence remains low, with the Conference Board index declining by 5 points to 93, similar to levels during the 2020 pandemic.

June’s retreat in confidence was shared by all age groups and almost all income groups. It was also shared across all political affiliations, with the largest decline among Republicans.

Conference Board: Consumer Confidence

The Conference Board’s Leading Economic Index (LEI) declined to 99.8% in June. Six-month growth in the LEI (blue) fell to an annualized -5.6%, below the -4.1% that signals a recession (marked in red).

Conference Board Leading Economic Index - Recession Signals

The black line on the above chart indicates negative growth in more than 50% of the LEI components below over the past six months. A broad decline confirms the recession signal.

Conference Board Leading Economic Index - Components

Dollar & Gold

The Dollar Index retreated below support at 98, signaling another decline. A breach of support of 96.50 would strengthen our long-term target of 90.

Dollar Index

Gold rallied to test resistance at $3,400 per ounce. A breakout above $3,400 would offer an immediate target of $3,500 and strengthen our year-end target of $4,000.

Spot Gold

Silver is testing resistance at $39 per ounce. A breakout would offer a target of $42, but declining Trend Index peaks warn of stubborn resistance.

Spot Silver

Conclusion

The S&P 500 closed at a new high, but declining Trend Index peaks warn of selling pressure.

The Dow Industrial Average respected resistance at 45,000, failing to confirm the S&P 500 bull market signal.

Financial market conditions indicate strong liquidity, but consumer confidence is weak, and the Conference Board Leading Economic Index signals a recession.

The US Dollar Index retreated below support at 98, triggering a rally in gold and silver. A gold breakout above $3,400 would offer an immediate target of $3,500 and strengthen our year-end target of $4,000. A silver breakout above $39 would offer a target of $42, but declining Trend Index peaks warn of stubborn resistance.

Acknowledgments

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Long bonds fall as CPI rises, stocks and gold remain bullish

Summary

  • Global long bond yields are rising, driven by fears over government debt levels
  • A sharp jump in services CPI warns of rising inflation in the broad economy
  • Strong liquidity boosts demand for stocks and for gold

Global long bond yields are rising, driven by fears over government debt levels.

Japan’s 30-year JGB yield jumped to a record 3.20% on Tuesday as opposition parties favoring tax cuts and loose monetary policy are expected to gain influence after the July 20 election. (Reuters)

German 30-year government bond yield is testing resistance at 3.26%, the highest since 2011. Investor concerns are focused on increased debt issuance—to fund defense and infrastructure spending—and rising international rates. (Reuters)

The 30-year US Treasury yield is testing resistance at 5.0%, the highest since 2007. The monthly charts below provide a long-term perspective.

30-Year Treasury Yield

10-year Treasury yields are expected to follow, testing resistance at 5.0%.

10-Year Treasury Yield

Rising yields are driven more by long-term structural issues than immediate concerns over an uptick in inflation.

CPI Inflation

CPI growth jumped to 2.7% for the twelve months to June, while core CPI, excluding food and energy, increased by 2.9%.

CPI & Core CPI - Annual

Sticky price CPI and the 16% trimmed mean, reflecting underlying inflationary pressures, jumped to 2.5% and 3.2% respectively.

Sticky CPI

More surprising was the sharp rise in CPI for services, excluding shelter, which is less affected by tariff increases than goods. The June figure is close to a 7.0% annual growth rate.

CPI Services excluding Shelter Rents

This confirms the earlier ISM Services PMI, which showed a sharp rise in the Prices sub-index in May and June. According to the ISM, fourteen of eighteen service industries reported increased prices paid in June. (ISM)

ISM Services Prices

Energy

Energy CPI showed negative growth for the twelve months to June, contributing significantly to the overall low headline CPI rate.

CPI & CPI Energy - Annual

Shelter

Shelter CPI comprises 35% of headline CPI. However, compared to the Case-Shiller 20-City Composite Home Price Index below, we find the index highly artificial and misleading.

CPI Shelter

Food

Food CPI growth increased in June to an annualized rate of 3.8%.

CPI Food

Stocks

The S&P 500 eased slightly in response to the CPI increase, but this is hardly noticeable on the monthly chart below.

S&P 500

The Dow Jones Industrial Average retreated from resistance at 45K. However,  rising Trend Index troughs signal long-term buying pressure, and a breakout above 45K would confirm the S&P 500 bull market signal.

Dow Jones Industrial Average

Financial Markets

Moody’s Baa Corporate bond spread declined to 1.73% after a sharp spike in March-April, indicating ready credit availability.

Moody's Baa Corporate Bond Spreads

The uptrend in Bitcoin indicates strong animal spirits, which are likely to spill over to stocks.

Bitcoin (BTC)

Dollar & Gold

The US Dollar Index is retracing to test resistance at 100 on the monthly chart below. Respect will likely confirm another decline, and our target of 90.

Dollar Index

Gold is consolidating in a bullish pennant on the monthly chart. Rising Trend Index troughs also signal buying pressure. A breakout above 3450 would strengthen our target of 4000 by year-end.

Spot Gold

Conclusion

Long bond yields are rising due to concerns over precarious public debt levels and growing fiscal deficits.

Inflation is still a secondary consideration, but a sharp rise in the CPI for services in June warns of higher inflation in the broader economy. Services are less impacted by tariffs, which are only likely to affect CPI after current pauses have expired and tariff rates are settled.

Liquidity remains strong, supporting high stock prices. A Dow Jones Industrial Average breakout above 45K would confirm the S&P 500 bull market signal.

Demand for gold is also strong, and a breakout above $3,450 per ounce would signal another advance, strengthening our target of $4,000 by year-end.

Acknowledgments

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Gold, the Dollar and a big hole in the desert

Summary

  • Stocks rallied on news of a ceasefire between Iran and Israel
  • But celebrations may be premature
  • The dollar weakened, which is likely to boost demand for gold

The S&P 500 rallied to test resistance at 6100. Breakout would signal a fresh advance, but declining Trend Index peaks warn of selling pressure.

S&P 500

Uncertainty remains high.

The White House was quick to claim victory after the US airstrike on Iranian nuclear enrichment facilities. But claims that the subsequent ceasefire is the start of a new era of peace in the Middle East will likely prove premature.

A ceasefire is not a peace settlement. It’s a pause in hostilities that allows both parties to rearm and re-strategize.

A precision strike is nothing more than a big hole in the desert, the effectiveness of which can only be determined by subsequent Iranian actions.

The damage assessment reported by CNN is premature, but it does raise some interesting questions.

The assessment, which has not been previously reported, was produced by the Defense Intelligence Agency, the Pentagon’s intelligence arm. It is based on a battle damage assessment conducted by US Central Command in the aftermath of the US strikes, one of the sources said.

The analysis of the damage to the sites and the impact of the strikes on Iran’s nuclear ambitions is ongoing, and could change as more intelligence becomes available.

….Two of the people familiar with the assessment said Iran’s stockpile of enriched uranium was not destroyed. One of the people said the centrifuges are largely “intact.” Another source said that the intelligence assessed enriched uranium was moved out of the sites prior to the US strikes. (CNN)

If the stockpile of enriched uranium were moved or otherwise not destroyed, how would this affect Israel’s security?

The only way to finish this is with boots on the ground. Neither Israel nor President Trump is likely to commit to that.

In the Treasury market, 10-year yields declined to 4.3%, easing the pressure on stocks.

10-Year Treasury Yield

However, the dollar continues to weaken, with the US Dollar Index testing support at 98. A breach would confirm our target of 90.

Dollar Index

The chart below shows how Brent crude and the dollar moved contra-cyclically, with the dollar weakening when crude oil prices rose, and vice versa.

However, that changed shortly before Russia’s full-scale invasion of Ukraine in 2022, the dollar strengthened despite a spike in energy prices, diverging from past behavior as investors sought safety. The divergence continues, with the dollar weakening while crude oil prices are falling. The dollar’s role is under threat.

Brent Crude & USD Index for Advanced Economies

Investors globally appear to be gradually reducing their exposure to dollar-denominated assets, driving the greenback down to its lowest level against a basket of major currencies in three and a half years….

According to Bank of America’s FX strategy team, European “real money” investors – institutions like pension funds and insurance companies – are the main drivers of the dollar’s selloff in the second quarter, slashing their dollar positioning to the lowest since 2022 in a matter of weeks.

But the story might not be so straightforward…. research shows that most of the dollar’s average daily declines in the last few months have come in Asian trading hours, suggesting Asian holders of U.S. bonds may also be increasing their dollar hedges. (Reuters)

Demand for gold remains strong as the dollar weakens, with the metal finding support at $3,300 per ounce. Respect of this level would signal another test of resistance at $3,400.

Spot Gold

Conclusion

Stocks have rallied, but uncertainty in the Middle East remains high.

Long-term Treasury yields have softened, but the dollar continues to weaken, reflecting uncertainty over the US role in the global monetary system.

Private investors have replaced central banks as major investors in US Treasuries. They are far more price sensitive, and both European and Asian investors are increasingly hedging their dollar positions, expecting dollar weakness.

A weakening dollar is expected to boost demand for gold.

Acknowledgments

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