Juliet Declercq at JDI Research maintains that the normal business cycle has been replaced by a liquidity cycle, where market conditions are dictated by the ebb and flow of money from central banks. Risk will remain elevated for as long as natural price discovery is suppressed and risk-reward decisions are made in an artificial environment controlled by central bankers.
The Fed is again expanding its balance sheet (commonly known as QE) in response to the recent interest rate spike in repo markets.
Jeff Snider from Alhambra Partners maintains that the Dollar shortage has been signaled for some time. First by an inverted yield curve in Eurodollar futures, well ahead of in US Treasuries. Then in March 2019, the effective Fed Funds Rate (EFFR) stepped above the interest rate paid by the Fed on excess reserves (deposited by commercial banks at the Fed). According to Jeff, this showed that primary dealers were willing to pay a premium for liquidity. The likely explanation is that they anticipated a severe contraction in inter-bank markets, similar to 2008.
When the spread spiked upwards in late September, the Fed finally woke up and started pumping money into the system, expanding their balance sheet by over $200 billion in the past few weeks.
Fed balance sheet expansion is normally welcomed by financial markets but broad money (MZM plus time deposits) is surging. Far from a reassuring sign, a similar surge occurred ahead of the last two recessions.
Bearish divergence between the S&P 500 and Trend Index on the daily chart warns of secondary selling pressure. An engulfing candle closed below 3000, strengthening the bear signal. Expect a test of secondary support at 2840.
Volatility (21-day) remains elevated. Volatility spikes at close to, or above, 2% normally accompany market down-turns signaled by arrows on the index chart. Note how rising troughs precede most down-turns and culminate in a trough above 1%. We are not there yet but Volatility above 1% is an amber-level warning.
CEO Confidence is falling and normally precedes a fall in the S&P 500 index. What is more concerning is that confidence is at the same lows (right-hand scale) seen in 2001 and 2009.
Exercise caution. Probability of a down-turn is high and we maintain a reduced 34% exposure to international equities.
