June Rate Hike and Brexit “Unlikely”

June’s Big News Events

The 2 major questions generating volatile price speculation are:

(1) When Will The Fed Hike Rates? A Fed rate hike had been given only a 29% odds of occurring last week, despite a very clear messaging campaign by multiple Fed officials that they were very anxious to raise interest rates ASAP. The Fed seems willing to ignore the weakening trend in economic data, but that debate may have been postponed until July with today’s reporting of extraordinarily weak jobs data. If today’s shocking 6 year low of just 38,000 jobs added represented a new trend then we would be jumping on the recession bandwagon. Our belief is that job growth is slowing from well over 200,000 a month, but 38,000 was an extreme outlier in a downtrend.  With today’s report the current consensus probability fell from about 30% to under 4% that a June hike is likely. We’ll state the obvious: a June rate hike would shock the markets! What about July? Odds makers rate a July hike at 31% probability. We would rate the odds higher for several reasons: (A) the Fed has implied that if there is “any” string of mildly positive economic data between now and mid-July, then they will hike. (B) With Presidential elections heating up this Fall there will be added impetus to grab any narrow window of data that is presented to enact one rate hike well before November to stay out of the limelight of heated rhetoric. (C) With a Brexit vote June 23rd that risks a financial panic reaction, the Fed would be wise to hold off until afterwards. Should economic data continue to surprise to the downside with jobs and GDP growth estimates, then any rate hike this year would become unlikely. We suspect earnings and economic metrics will improve modestly during the 2nd half of 2016, but the risk of investors sitting on their proverbial hands is a potential headwind until well after the November elections.

(2) Will Brexit Occur?   The Brexit vote for the UK to leave the EU is not factored into markets and would be damaging. A vote to remain in the EU would be a mild positive as such an outcome is partially accounted for. The current Bookie odds of keeping the UK in the EU is 73%, which we will use to conclude a market friendly outcome that will boost the British Pound’s value.

Review of Markets:

US Stocks Entering Short Term Topping Window 

The one year trading range in stocks that witnessed 2 double digit corrections in the benchmark SP 500 Index and Dow is near an end. We expect a price peak between here (2100) and about 2030 in the SP during June followed by a correction of less than 10%. Our forecast this summer is for a further rally to Dow 18,100 – 18,200 and SP 2128 – 2135. The trader sentiment shown below is only a 5 day put to call option ratio, but we can see that it often indicates a short term peak is near when this ratio falls beneath 60.

Option sentiment 6-3-16

With the markets strong expectation that a Fed rate hike is off the table for June and declining odds for hikes throughout 2016, stock prices have added yet  another reason for prices to rally. Extreme oversold sentiment data in the first half of May after a very minor price correction has created a classic “wall of worry” propelling stocks toward record highs. After a year of sideways price action  a tremendous amount of sideline demand has accumulated and is becoming a magnet the closer prices creep toward their 2015 peak of SP 2135.  A return from almost no GDP growth (0.7%) to slow economic growth will be enough to turn the earnings drought back to greener pastures, but with elections, rate hikes and the unknown China economic wild card we would not expect stock prices rise more than 3 to 5% further this year after the June peak and pullback is over.

British Pound Ready For Appreciation

A Brexit vote to leave the EU would indeed be Bearish for the British Pound and send a chill throughout most of the global financial markets. Under a Brexit we would be short the Pound. As the London Bookies deem such a YES vote to be very low odds, we will then focus on a NO vote that keeps the UK  in the EU. Such an outcome has been partially discounted, but there is enough negative sentiment built up in hedge funds, combined with a very tight trading range, that the upside potential for the Pound is attractive for currency investors through futures or ETF stock (symbol FXB). 

British Pound 6-4-16

A test of 150 to 152 by late June-early July is our current expectation. A Yes vote on June 23rd and break below 14340 would be very Bearish.

YEN Defies BOJ Efforts to Devalue

In May we talked of the Yen needing to move lower due to the negative sentiment extremes by Funds and it did. The one month leg lower in the Yen partially satisfied the overbought sentiment moving from 95 to 90. Liquidation occurred, but not even close to what would be required for a longer term oversold Buy signal to trigger Fund reversals. The Yen reversed sharply higher this week from 90 to 94 after the Japanese Prime Minister announced massive Fiscal stimulus and postponement of deficit reduction tax hikes. This may have been the “tell” that sends the Yen back to new highs. We moved to a net long position Thursday expecting a test of 95 as long as support at 90 holds. Our estimate is that prices will need to move to new overbought spec fund extremes with an appreciated Yen valuation near 99 to 100 before triggering significant Bank of Japan (BOJ) intervention. US Dollar weakness and higher Gold will be necessary for this up move in the Yen to transpire. Should the upper 90’s be reached we suspect that Large Specs will reach new multi-year overbought positions and combine with BOJ Selling to provide a good area for investors to Sell the Yen and Buy Dollars.

Yen 6-4-16

Interest Rates Still Falling!

For years we have heard about the Bond Bubble and how interest rates will rise, perhaps sharply due to inflation and unwinding of central bank balance sheets. This has been a naive outlook failing to understand the deflationary pressure exerted by excessive debt and overcapacity in a massive demographic aging of the industrialized world. Even with energy prices rising steadily for 4 months along with other commodities, interest rates are still “falling” – with prices rising. An employment rebound and continued rise in valuations of commodities, especially Oil and Copper, would eventually reflect higher economic growth rates and renewed inflationary pressures. For now economic trends are down and Bond prices are breaking higher out of a congestion pattern and yields are falling to multi-month lows. A price target window of 169 to 172 is the current potential should this breakout hold.

TBonds 6-4-16

Opposing Directions of Gold and Oil

We have covered Oil and Gold in detail recently. The overbought conditions of Gold and Silver we noted have been partially satisfied with their very sharp down-moves in May. A modest rally here would not be a surprise, yet seasonality and fund pressure could keep prices subdued until July or August. Normally it would be common to see energy and precious metals move a bit more in sync, but Oil has maintained its rally mode after reaching our 1st quarter forecasts above $50/barrel. While a modest correction into the lower $40’s in WTI Crude Oil  is logical, it’s may be a bit too popular of a target in the near term. The $48 to 50 area is pivotal and holds out the possibility of another new high in the low $50’s soon before a more serious overbought condition begins to prevail upon Oil prices. We have discussed the significant inventory drawdown that was due to begin in April/May and continue through about August that allowed upward supply/demand pressures to continue into at least June. Our  2016 investment advice was on the long side from the upper $20’s to lower $50’s, beyond that we would advise being on the sidelines until more extreme overbought or oversold conditions appear. Some are still calling for $10 Oil even if the global economy is in growth mode, which we again state is a chimerical perspective requiring a global recession to occur. A year ago we stated our forecasted 1st half 2015 Oil rally would not hold. This year we have stated that our forecasted rally would hold. That is, $26 Oil should not be tested, unless a recession is upon us. Any Oil price drop back into the $20’s would be a major blow to the anemic global economy and signify major trouble in many financial markets requiring a shift to a more defensive investment strategy.

Oil production 6-5-16

Lousy Time to Raise Rates

The global economy is near the low end of its new low normal growth pattern since 2009 and still vulnerable to a panic recession as attempts to remove quantitative easing (QE) in the US may spread to Europe in 2017 when their QE expires. An effort to raise rates in such a weak environment for the misplaced desire to regain more monetary policy tools is a risky gambit. The Fed and most economists are worried that the US economy will begin overheating if they don’t tighten credit faster with rising interest rates. There is no metric we see of an inflation and excessive growth rates in the US or any economy around the globe. If demographically impaired unemployment rate of 4.7%  is a primary measure of overheating, then our confidence in the real world IQ of economists is quite low indeed. Core prices are weak, wage growth is moderate, European QE is in its final innings and Japan is already running into a wall on its current QE effectiveness with negative 10 year bond rates. Add to this the Global PMI Service and Manufacturing sectors heading toward stall speed again with the abysmal 38,000 US jobs created in May  and tightening bank credit standards this late in the economic cycle indicates to us we should be cautious and The Fed should lay off the brakes.

PMI 6-5-15

 

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