Fed Unwinding Triggers Rates To Rise, A Dollar Reversal And A Boost To Financials
- Dollar begins a short-term rally
- Fed action boosts rates
- Financials set to move higher
Fed action on Wednesday had the effect of boosting rates, thereby causing short-term reversals in several markets and relationships. These inflexion points in the markets are expected to influence prices over the next few weeks.
Dollar begins a short-term rally
Last week I pointed to some long-term indicators that identified the Dollar Index as being in a primary bear market, as well as some shorter-term ones that suggested a near-term rally could soon get underway. The problem, was that no trend reversal signals had taken place at the time. That changed today when the Fed announced a slow unwinding of their balance sheet. That sent rates higher, thereby boosting the dollar. Chart 1 shows that the Dollar Index ETF, the UUP, has just broken its July/September down trendline and rallied above its mid-September high. Note that the KST has just gone bullish. More important, is the fact that the Index experienced and outside day on Wednesday. Outside days develop when the price totally encompasses the previous session, the more so the better, and Wednesday’s action was quite impressive in this regard. The Euro has a 57% weighting in the Index, so a lot depends on the action of that one currency.
Chart 1
However, Chart 2 shows that the Wisdom Tree Bloomberg US Dollar Bullish Fund (USDU), a far more broadly balanced entity, has also broken to the upside. Its KST has tentatively moved above the 2017 down trendline.
Chart 2
Finally, my Dollar Diffusion indicator, in Chart 3, has started to reverse to the upside from an oversold reading. This series monitors a basket of cross dollar relationships, such as the dollar euro, dollar yen etc. that are in a positive trend. It’s not a perfect indicator, as you can see from the dashed arrow last March. However, the majority of the time when it goes bullish and such action is confirmed by a trend break in the price itself, it works reasonably well. That trendline confirmation took place on Wednesday.
Chart 3
One spectacular reversal that also took place on Wednesday, was for the Australian dollar, which is featured in Chart 4. This currency experienced a bearish key reversal day in early September and tested that high again on Wednesday. The rally took the price temporarily above the green resistance trendline and the red June/September extended trendline. Since it was unable to hold above that resistance by the end of the day Wednesday’s action re-confirms the bearish action of the key reversal. The KST is slightly bearish, but the implied vulnerability by Wednesdays exhaustion action suggests both it and the Aussie dollar are headed lower.
Chart 4
Fed action boosts rates
Chart 5 displays the 10-year Yield for the US, UK, Germany and Japan. Their levels may be different, but they have all experienced similar trajectories in recent years. The green trendlines have been plotted to suggest that each country may be close to an upside breakout. In these situations, it’s often a good idea to look for a leader. In this case we look to the UK as it has tentatively broken out.
Chart 5
You can see this more clearly from Chart 6, where all three KSTs are in a bullish mode. There seems little doubt that British rates are headed higher in the period ahead, but what of the US?
Chart 6
In this respect, Chart 7 shows the 10-year yield. It looks as though it may be in the process of forming a 3-year reverse head and shoulders. However, that would require a decisive break above the 3.1%, level, which is some way away from the current reading. A more achievable target is the dashed “right shoulder” down trendline, which is currently intersecting with the 65-week EMA at 2.82%. Momentum indications are quite mixed with none of the KSTs offering a decisive signal in either direction. However, if the yield can rally, say, to 2.9%, that would probably be sufficient to tip the three KSTs into the bullish camp.
Chart 7
Financials set to move higher
In recent years when rates have moved higher this has stimulated financials, because of wider profit margins. Consequently, if rates do advance from current levels, this should be reflected in a strong technical position for financials. Chart 8, shows that the Spider Financials, the XLF, moved to a marginal new high on Wednesday. I am not going to call this a breakout yet because it’s not decisive enough. However, all three KSTs are in some form of a bullish position, so momentum argues that we will see a decisive breakout in the immediate future.
Chart 8
That’s important, because rising relative strength by the financials is bullish for stocks in general. In this respect, Chart 9 compares the S&P to the relative momentum of the XLF. The green shaded areas flag periods when the long-term relative KST for the XLF is in a rising mode. Under such conditions the S&P usually rises. Right now, the KST is above its EMA, which is bullish for equities. Nevertheless, you can also see that this momentum indicator has started to ever-so-gently roll over. Unless the XLF itself can continue to power ahead it will reverse and cross below its EMA. That won’t necessarily represent a bad omen for stocks in general, but it will remove what is currently a bullish prop.
Chart 9
Three industry groups that fall under the financial banner are Asset Managers, Brokers and Banks. They are plotted in Charts 10, 11 and 12. All three have broken to the upside and are experiencing superior relative action. The first two are of particular interest since they both benefit from a rising stock market. Just as stocks in general discount the economy, asset managers and brokers have a tendency to discount the market, so a breakout in these leading stock market areas is not a bad thing!
Chart 10
Chart 11
Chart 12
Good luck and good charting,
Martin J. Pring
The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group of Walnut Creek or its affiliates.
