Shadow Capitalism

Risk assets plunged today, with Nikkei futures seeing a 250 point drop Thursday overnight, as the Yen was bid heavily across all pairs, with funds flocked to safe haven and carry trades reversing course. Several commodity FX yen crosses are on the precipice of head and shoulders breakdowns, after selling off heavily back to their necklines. Today’s biggest mover in FX was CAD/JPY in fact, which is very deflationary. Commodities in general are losing their fundamental bid. Intermarket corrs are at 1987 crash highs, eliminating the diversification premium investors offer for commodities. And global growth slowdowns, austerity, and deflationary threats in Eurozone, USA, & Japan are bearish for commodities, the nations that export them, and risk in general.

Speaking of commodities, the Aussie Dollar suffered big selling as well, both against JPY & USD. The skyrocketed nominal housing prices and very hawkish rate policy since crash lows could turn out to be more bearish than bullish if exports to China slow, as Chinese economic data and the one-time nature of its stimulus package suggest. With the Baltic Dry Index posting record consecutive losses, global trade probably will not be a “way out” of bearish developments in the forthcoming months.

On a technical basis, the AUD/USD seems to have double-topped at its June highs and was unable to break up to or back above its 200DMA (which price has had very high confluence to), leading to its current bear flag formation. As my technical analysis and FX Concept’s Jonathan Clark’s views suggest in the charts below, it appears to be a great short. The AUD/JPY does as well, as it found selling at its 55DMA and appears primed for a move down to 72.50 and 70.00 support levels, the latter of which corresponds to April 2009 levels.

And with the Aussie Dollar, so goes copper, as it is primed for a breakdown through the 2.60-2.70 zone, after finding selling at its 55DMA.

Even gold has bearish chart developments, breaking down through its 55DMA and subsequently forming a bear flag. The long gold/short euro trade on sovereign debt crisis was a popular and crowded position many traders took during the euro’s plunge but with the recent diminished-interbank-funding-fueled euro rally, many of these positions will most likely be facing liquidation and unwinding. The chart below exemplifies the recent inverse relationship between gold and euro (historically not the case) with DZZ (inverse gold ETF) and EUR/USD spot.

With AUD, CAD, copper, oil, and gold selling off big and showing very bearish chart developments on intermediate and long term time frames, the markets currently imply very deflationary developments.

The biggest news in JPY space, however, was the USD/JPY breakdown below 87 support. The cross experienced a breakdown last November through that level but it reversed course very quickly. The last time the dollar fell below that level for a material amount of time was 1995, which subsequently led to the BOJ instituting ZIRP. Fifteen years later, Japan hasn’t changed policy and nominal rates cannot fall any further. BOJ intervention is becoming increasingly likely. This time around, however, the sovereign sector is levered up and further monetary easing may lead to secular shifts in perception and eventually result in a JGB crisis (previously out of the question due to the private/financial sectors being the ones with bad debts, which inherently causes a rush to safety of its yet-to-be-levered up government’s bonds).

Equity space also found big selling today, with the S&P down 2.88%, after finding huge resistance at its 55DMA (starting to sound familiar?). The head and shoulders (neckline 1015) remains in play and deteriorating price and expanding volume to the downside suggest this down move will be sustained for some time. The head and shoulders target is around 815, near February 2009 lows/support. A chart of the SPY ETF proxy is posted below, to show volume as well as price action.

And with the 12 month moving average breaking down (and subsequently retracing and resuming selling), this wave down is implied to be a longer-term selloff rather than a correction.

The technical confluence in all of the charts of risk assets is an alarming development. With so many assets (in all classes) sitting on head and shoulders support levels after selling off from 55 and 200DMAs on heavy and expanding volume, the downside risk to risk assets is very high and a strong move down appears the most likely scenario.

This also coincides with the safe havens finding strong bids, namely USD, JPY, & Tsys. 10Yr yields are back below 300bps (as we were expecting in previous posts) and still implying much further price declines in equity, a correlation we have been tracking for weeks.

Everything is moving in tandem, which is indicated in inter- and intra-market correlations at or near all-time highs. Meanwhile, the JCJ Implied Correlation Index closed today just under 75, implying crash risk is elevated.’

The selling in risk implies a rush to cash globally, with the currencies with largest debt outstanding finding the largest bids ahead of deleveraging. Interbank funding costs have also dramatically risen, especially in Europe, where the Euribor-EUR Libor spread is spiking, indicating a larger portion of marginal interbank lending is occurring at the higher end of reported rates. Again, very deflationary developments.

And market internals aren’t any better, with breadth very negative and volume expanding greatly as markets selloff. The 20DMA on SPY volume is currently about 40% higher than just last March, in the middle of the exhaustion phase of the massive rally. In addition, July 6 saw the first “Hindenburg Omen” issued since July 2008, two months before the stock market crash. There were also Hindenburg Omens issued in June 2007, four months before the all-time top in American equity markets. Historically, these occurrences resulted in a 5%+ move to the downside 77% of the time and have preceded every major market crash. We don’t expect another crash of fall 2008 proportions, but we do expect a strong move down in risk markets, possibly in all-out panics in certain assets, such as certain commodity currencies vs JPY & USD and specific Euro nation bonds (specifically CEE and Spain).

Economic data is supporting what the markets are beginning to price in as they reverse and sell of, on big volume. The ECRI LEI came in today at -9.8, which historically has always preceded a recession. Consumer confidence at 66.5 vs 74.5 consensus vs 76.0 prior. And the below-consensus China GDP numbers have been adding downside pressure as well. It appears that global growth recovery has peaked and as peak stimulus is spent and a global push for austerity is underway, deflationary forces are beginning to be priced back into the market.

And Hungary’s breakdown of talks with IMF & EU signify two things: 1. without austerity (and consequently significant economic deterioration), nations (esp CEE) will not qualify for IMF funding; 2. the Hungary situation will bring back the theme of European sov debt crisis, which should shift the EUR trend back down as interbank funding loses thematic importance to sovereign funding; and 3. go long USD/HUF and CHF/HUF and stay long.

The S&P has rallied almost 9% in seven session off the lows seen on the first day of this month. Volume has lagged, however, and as we come to test the 50DMA & 200DMA, downside risks are back into play. The head & shoulders “breakdown” through S&P 1040 was a bear trap, confirmed by the ridiculous 54% AAII bearish readings that week. A jump from mid-30s to mid-50s is unsustainable and showed that everyone had gone risk-off on a technical pattern. The true head & shoulders, however, is at the 1015 level, the Oct 2009 & July 2010 lows (as well as July 2009 highs). Flow data has confirmed short-covering and fast money has rallied the market, with no conviction as per volume data.

Meanwhile, the 10yr Tsy yield, as mentioned in the previous post, retraced back to its 310-315bps breakdown level (and subsequently sold off), suggesting the risk rally is over, at least implied by the bond market. This confluences with the moving average resistance in the equity indices, suggesting risk may find selling here. The recent divergence between Tsy yields & equity suggest equity is overpriced, if the bond market is taken to be the leading indicator that it has been since April when it failed its 400bps breakout and reversed course downward. The 10yr yield corrected back up to June lows but never got above those levels.

After the YoY 10.3% Q2/11.1% H1 GDP growth data from China, the AUD/USD went vertical, shooting up 50 pips in a matter of minutes. But since then it has retraced all of those gains and against the backdrop of overbought risk markets facing all kinds of resistance, its .8780-.8860 range seems at risk for breakdown and consequent resumption of downtrend.

Iron ore, copper, and coal prices are down significantly from their highs, while China is cooling itself down in an environment of global austerity (aka decreasing import demand). Global trade has all but halted, as judged by the Baltic Dry Index, which is on its 37840th consecutive day of decline.

These factors do not bode well for the Aussie Dollar, and all it takes is a little risk aversion to send it underperforming and exposing the RBA’s rate hikes as malconceived. The high rates will eventually pop the Aussie property bubble (one of only two remaining bubbles Jeremy Grantham observes), furthering the downside risk, and probably leading to a reversal in rate policy from the RBA, which would be an embarrassing turn of events that would be disastrous to Australia’s currency & equities. The RBA effectively leveraged the entire Australian economy and growth story (via rate hikes) into the China export story. But that is one-time demand, from stimulus engaged at the depths of the financial crisis, and the global push for tightening and austerity will most likely send Australia into its first dose of true recession and skyrocket its employment (currently consisting of millions of miners supplying China’s now-peaked demand for building commodities). The Shanghai Composite (in bear market territory) isn’t making things look any better, either.

Bank earnings are coming up for American stocks and the technical backdrop shows a low-volume rally that has brought financials back up to significant resistance & the 200DMA in the context of a major head & shoulders topping pattern. There’s always a chance blowout earnings result in bank stocks breaking out, but at these levels even good results will probably result in selling the news. With recent market vol, trading volumes and leverage used by hedge funds has declined dramatically (even getting WSJ exposure), while hedgies have faced big redemptions in the face of poor May & June numbers (Paulson may single-handedly be catalyzing the selloff in gold with his big redemptions after an abysmal May & June).

JPM is on deck tomorrow for earnings. Let’s take a look at how the market has fared in the past few quarters following JPM earnings. Market loves to pump on low volume ahead of JPM results, only to dump on high volume subsequently. The technicals imply this pattern may continue this quarter, as well.

On smaller timeframes like 30min/hourly charts, we still have higher highs & higher lows, suggesting risk is still bid. But with heavy resistance above, low volume behind the rally off July 1 lows, a poor macro backdrop, and slowing momentum, we could see some distribution resulting in a reversal of trend. My take is that this may be near the top of this move, judging strictly by technicals. JPM (and subsequent bank) earnings may provide catalyst for movement.

Quick update, will probably be back here later tonight.

China econ data being released in 10mins (10pm EST)… should be significant for risk FX crosses, particularly those dependent on Chinese growth (AUD/USD I’m looking at you).

Retail sales came marginally below consensus while INTC blows up but earnings gap is faded heavily (following AA’s and CSX’s suit). What was thought to be THE catalyst for equity this week turned out to result in surprisingly low vol.

JPM numbers tomorrow should move markets. With rising hedgie redemptions, declining hedgie margin and trading volume, spiking capital market vol, and high intramarket corrs, principal & agency trading revs should come in with big declines and that will hurt fin EPSs. My guess is below consensus + sell the news.

S&P testing resistance at 50DMA and right below 200DMA (SPY at 50/200DMA cross). After seven sessions of rallying on no volume, bear market resumption could be upon us.

10yr yields retraced to the 310-315bps level I’d been harping about and sold off today back to 305bps. Suggests risk will be sold from here and the weak bounce in yields from cycle lows implies equity is overvalued and remains in fundamental downtrend. Moving average resistance will be key here.

Be back later.

-Naufal

Submitted by Qasim Khan

Soccer is a beautiful game; unfortunately, World Cup finals usually are not (today’s in particular) and for an obvious reason: the stakes are just too high. de Jong’s first half karate kick was so egregiously perverse that it was almost surreal. For as much flack as they get (see Jim Joyce), referees are stuck with the impossible task of sorting out nearly unparalleled mayhem. It’s disheartening to see a World Cup that has had such compelling storylines and beautiful play, capped off and likely defined by such an awful spectacle in front of its largest audience.

It’s not that everyone involved lacks respect for the game; it’s just simply the fact that when there is a World Cup to be won, nothing else really matters. Arjen Robben captured this beautifully going into the final when he said, “The intent is there to play good football, but the result is far more important. We have heard enough of talk about how our football is very nice. But it gets you nowhere. We want to achieve something.”

Ironically, it was Robben who illustrated his point to perfection today. After a beaten Puyol committed every possible foul to impede Robben on a breakaway, Robben had to make a difficult decision: go down or go for goal. He actually had legitimate justification to go down; Puyol would have very likely received a red card and Netherlands would have been in very good position to secure its first World Cup. But Robben chose to stay on his feet, went for the glory and came up empty (to be fair, it was a beautiful save by Saint Iker). No card. No goal. No World Cup. Nothing. And after all the previously confused musings, it dawned on all spectators just why soccer players flop, fake and in some cases, outright cheat.

And that is the problem with the world of finance. Every day is the World Cup final. Trillions of dollars. Creation and destruction of societies. The stakes are that high; so players will flop, fake and play dirty because at the end of the day, no one remembers or cares about second place. Like their referee counterparts, regulators find themselves in the impossible position of judging unbelievably talented people who are willing to do just about anything to win. Which is why when I see headlines like this weekend’s “Bank of America Says $10.7 Billion of Trades Wrongly Classified,” I really am not surprised anymore.

The 10yr broke the important 310bps support level I’ve been highlighting for a couple weeks now. The risk aversion expressed by the demand for Tsy notes manifested in a more pervasive risk asset decline today, in equity, credit, and FX.

Meanwhile, GS FX sales strat issued a report recently highlighting two very important technical developments we’ve been repeatedly speaking about: the 1040 H&S in the S&P and the 10yr 310bps level. The report is below.

On the economic data front, the Chinese LEI was revised downward to 0.3% from 1.7%, causing Chinese equities to fall. The Aussie Dollar also plunged on the news, as did copper. The Australia-China-USA “love triangle” pervasively covered on ShadowCap is quickly becoming a closely-followed theme in financial news.

After the big gap-up on Monday on news of the CNY floating, the market hit its 50DMA and has done nothing but selloff since then, with four consecutive red days. As I stated in previous posts, the right shoulder of the big 8-month-long pattern in the equity indices seems to be in-the-making and 1130 may be the lower high defining the new downtrend. Still watching the 1040 neckline level as the big sell-off trigger.

The 10yr note yield that I’ve been mentioning as a risk indicator did indeed breakdown out of its triangle pattern and is now bouncing off of support at 310bps. This provides credence for a short-term bounce in risk, and indeed we hedged out short book today with a nice high-beta chart (view trades here), but our intermediate-/long-term prospects remain bearish. Watch the TNX 310bps level breakdown to indicate risk aversion and to lead the 1040 level breakdown in the S&P (credit leads equity).

ICI reported yesterday that another $1.8B was withdrawn from long equity mutual funds last week, bringing the YTD outflows to $29B. Meanwhile, Dean Baker and Meredith Whitney have both expressed bearish outlooks for housing in the US recently, as May new home sales plunged a record 32.7% vs. -18.7% consensus and 14.7% in April. The housing double-dip has officially arrived.

Meanwhile in Europe, the situation continues to regress, as Greek 5yr CDS broke a new high to 1075bps. Portugal’s 5yr bond auction came at a 4.657% yield, a full 957bps higher than last May’s 5yr auction, while its ECB bank borrowing doubled MoM to €35.8B in May. Portugal is the new Spain, which is the new Greece, which is the new Lehman. Portuguese Emergency Stability Fund qualification is imminent.

Lots of talk of Chinese liquidity drying up. Zero Hedge has been all over this, reporting the 30day repo surging to 425bps, a fresh record. This, combined with the Aussie super-tax and Australia’s PM resigning, could break down the China-Australia-US economic complex and lead to a collapse in the Australian & Chinese property bubbles, drive the USD higher, collapse the copper bubble, and lead to further liquidity crunches throughout the world at the interbank level.

Submitted by Qasim Khan

Overview

Markets have viewed China’s willingness to move to a more “market” determined value of CNY as an indication that Chinese officials believe the global economy is strong enough to weather a CNY revaluation. However, I contend just the opposite. What if China fears increased risk reversion as the worldwide economy slows down during the second half of the year? What if they are moving away from a peg to the USD because they are afraid that USD will appreciate significantly during an onset of risk aversion? Given the increasingly likely double dip scenario, China’s move toward a “market” based CNY value may ironically only exacerbate global imbalances.

Thesis

In further proceeding with reform of the RMB exchange rate regime, continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies. The exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market.

China’s external trade is steadily becoming more balanced. The ratio of current account surplus to GDP, after a notable reduction in 2009, has been declining since the beginning of 2010. With the BOP account moving closer to equilibrium, the basis for large-scale appreciation of the RMB exchange rate does not exist. The People’s Bank of China will further enable market to play a fundamental role in resource allocation, promote a more balanced BOP account, maintain the RMB exchange rate basically stable at an adaptive and equilibrium level, and achieve the macroeconomic and financial stability in China.

-PBOC Statement

Much has been made of the PBOC’s recent decision to allow the CNY to “appreciate.” As I have argued since the announcement, it has become clearer that this “revaluation” was more pre-G-20 political posturing than an explicit declaration of a change in policy. However, as superfluous as the PboC’s statement was, its ambiguity may be more revealing than any change in policy could have been. Emphasizing a transition to a two-way, “market” price rather than identifying the particular aim of appreciation was a signal to skeptics like me that China had an ace up its sleeve. Market action has since corroborated such suspicions as the CNY has actually depreciated since Monday night’s fix and a recent WSJ report stated, “Traders on Tuesday said they saw signs that state-owned banks were buying dollars, in what was interpreted as a push at the behest of China’s central bank to push down the yuan’s value.”

Is it a shock then that they’re “de-pegging” now? Not really. China has never been one to succumb to international pressure, so clearly Chinese officials intrinsically believe the move to be in China’s best interests. In fact, given current economic uncertainty (sovereign debt crisis, drying up liquidity and stimulus effects, global austerity measures, etc),we may soon find that China’s de-pegging from USD is no concession on their part.

The crux of the thesis relies heavily upon slowing economic conditions, due in large part to the evaporating effects of fiscal stimulus and greater calls for fiscal austerity. Now it’s rather rare that I agree with Paul Krugman on anything, but as opposed as I am to deficit spending on such a massive scale, the fact of the matter is that deficits are there to be enacted countercyclically to help economies recover during periods of burden (not when economies are humming along, as has been done).

This situation is similar to airline companies, horrified by the movement in oil prices in 08, hedging their oil exposure at the height of the oil run up. The fact is these decisions are best made when they CAN be, not when they HAVE to be. Now is not the time for austerity; the time for austerity was before when we weren’t facing an economic downturn of extraordinary proportions. George Soros agreed with this belief earlier this week when he stated that the recent austerity measures in the Eurozone ensure a second recession in the near future.

The sovereign debt crisis presents a uniquely potent danger because it not only affects financial institutions with exposure like the ‘08 crisis, but the government backstops that essentially “resolved” the previous crisis as well. Given global financial interconnectedness and risks of contagion, its ramifications are not centrally concentrated as many would have you believe. This dilemma is not a Euro-specific issue; the US (especially on the muni level), UK and Japan are all going to address their imbalanced and unsustainable fiscal policies soon, as well.

Many market participants argue that the revaluation provides another outlet for tightening domestic conditions. However, what if instead of seeking another way to further tighten conditions, Chinese officials are worried they have tightened too much? Domestic tightening measures to control inflation have slowed growth and left the country increasingly vulnerable to potentially severe deterioration in global economic conditions. If USD appreciates against most currencies (all except JPY), as it tends to do during times of economic and financial distress, then perhaps this move was in all actuality protection against further CNY appreciation. The fact of the matter is this “flexibility” affords them greater economic control by creating a potential hedge against a flight to liquidity/safety (USD appreciation) that would accompany a worse than expected second half of the year. Rather than waiting for the downturn to manifest and attempting to revalue/devalue CNY, which would be exceedingly conspicuous and politically damning, they may have just jumped ahead and created protection in a much more opaque and politically convenient manner.

Ironically, if we do experience the dreaded double dip, the rest of the world may then realize that it CANNOT afford to let CNY appreciate given its absolute dependence upon their export driven model to fuel worldwide economic growth. Furthermore, resulting positive feedback could spell trouble for any hope of sustained global economic rebalancing. Specifically with respect to Sino-US relations, if global growth slows severely enough the US could potentially find itself begging for China to resume its export driven model to provide some source of economic growth for this world. This in turn would only spur more political tension, leading to greater protectionism and thus worsening global economic conditions. If anything, trade and economic imbalances would be further exacerbated, fueling the unsustainable yet another unsustainable force in the global economy.

…And that would spell harm for riskies. 10yr Tsy yields are about 10bps less than when we mentioned their relevance to risk assets earlier this week, although one could say they remain in their consolidating triangle. The prospect of an imminent breakdown in yields is looming, however, and a selloff through the 310bps level could be game over for equities and commodities.

Certainly the fundamentals are there for a risk asset decline. Initial claims came in today at 472k vs 450k consensus, as the US employment picture looks bleaker by the minute. Presented below is a chart of jobless claims (inverted, 4wk moving avg) vs the S&P, courtesy of Bespoke Investment Group:

Meanwhile, the Philly Fed diffusion index dropped 13.4 points to 8 vs. 20 consensus, and May CPI declined for the second straight month to -0.2%, the lowest level since December 2008. The leading indicators mentioned in previous posts (ECRI LEI, retail sales, etc.) are warning of a double-dip, while coincident and lagging data are now suggesting the possibility as well. Shrinking tax receipts and swelled budget deficits are starting to take a toll on muni’s, as MCDX components begin their widening. Growth has clearly stalled and the stimulus hangover is now upon us.

One of the symptoms of the spending hangover is the sov debt crisis that has begun in earnest in the European periphery and is making its way to larger Euro economies. As mentioned previously, Spain is in the cross-hairs presently. 10yr ESP Tsy spread to Bunds are in the 335bps region, while the bond auction today resulted in the 30yr going for a 115bps yield premium to last month’s auction. The Kingdom has to roll over about €20B by the end of July and with record (and increasing) ECB deposit facility usage, it looks like a liquidity crisis could hit Spain this summer. It has a property bubble yet to really mean-revert (prices only down 11% from peak), huge unbooked losses on bank balance sheets, and austerity in an already-20%-unemployment environment. With aversion to interbank lending (record ECB deposits + EURIBOR creeping up), Spanish banks are already suspicious of each other’s balance sheets and as more funding is needed, more granular looks at each other’s books will occur, which will expose lots of unrealized losses (similar to fall 08 in USA). Meanwhile, the sov sector is going to have a tough time rolling over its massive redemptions in July, and as Spanish bonds fall, the Spanish banks’ books will come under even more pressure.

But those are fundamentals and macro. Not always the most relevant factors for price action in this market. Equity could continue rallying into the summer, though this bounce off recent lows is suspect in volume (as well as in the fact that market leaders have been selling off and put in major tops). I’m looking for a failure at the 50DMA/1150 resistance level, which would mark the right shoulder of a large h&s (delineated in pink in the SPY chart below) that has been developing since last November. If that is indeed what occurs, the 1040 neckline, when breached, should usher major selling and would be a prime shorting opportunity. Indeed, ICI reported a $3.7B outflow form equity mutual funds last year, bringing the year’s total to $27B. But that’s all speculation; this market has a mind of its own and if we go on to April highs or beyond, it won’t be the biggest surprise. One thing is for sure though: with global growth now stalled, an acute liquidity crunch in Europe, massive debt maturities in the next few months, and a still-rallying USD, whenever we do sell off, it should begin a strong and long wave down.

Speaking of liquidity crunches, BP is tendering a $10B bond issue, with 5yr CDS spreads close to 500bps, as well as selling $10B in assets and seeking a $5B credit line. This is an acute liquidity crunch, as BP has burned through 15% of its cash holdings in just a month. If equity and note declines continue, contagion could result– BLK’s equity value has already dramatically declined since the Deepwater Horizon explosion. Rumor is PetroChina may LBO BP if it drops below $15 PPS, which would have big political ramifications. Expect continued curve inversion.

But back to the possible imminent breakout in Treasuries– as we stated, US sov FI finding a bid will signify (near-term) deflation and risk to risk assets, as there’s a rush to “safety” and liquidity. Billy Gross over at PIMCO, for one, sees a Tsy rally in the works: TRF’s bond holdings jumped by $35B MoM in May, bringing them to 51% of all holdings (from 36% in April).

Go England.

In our “Sell in May & go away” post, published hours before the Flash Crash, we wrote about the Australia-China connections, especially in regards to commodities (particularly copper):

Liquidity tightening in China and the Australian mining super-tax are further important catalysts for commodities selling, particularly in copper, which in our view is currently in a bubble. Indeed, copper prices are down over 15% in the last month or so. Meanwhile, the “draconian” measures out of China to curb housing price appreciation and speculation are sending property and property-related names plummeting.

On this thesis, we went short Freeport McMoran (FCX) as a proxy for negative exposure to: 1. (unwinding) copper (bubble); 2. (diminishing) demand from (imploding) China; 3. (unwinding) USD-funded risk carries.

Today, Bloomberg presented an interview with Jimmy Chanos, in which he details, among other things, his proxies for shorting the Chinese property bubble. One of the media he mentions is through “first derivatives” of the property boom, namely the supply side and miners.

We have no idea whether he’s short FCX (or TAO, which we also mentioned in the “Sell in May & go away” post), but the interview is a fascinating view, particularly in the parallels that can be drawn from Chanos’ and our theses:

Volume is nowhere to be found, which means risk was heavily bid and price marched on upward today. US FI saw outflows on short-end, with 3mo bill yields going up 2.5bps, but 10yr & 30yr Tsys saw minimal offering, diverging from the breakouts witnessed in equity & commodity/FX space.

The hourly chart of the 10yr Tsy yield shows a consolidation of the April-May risk aversion occurring. If yields can get a break above the 3350 level, that may indicate more risk appetite and continuation of risk rallies. If the level poses resistance and we get a selloff back to late May lows, expect risk to follow suit.

SPY & AUD/USD both broke out through late May/early June cycle highs today, with SPY/ES/SPX breaking their 200DMA as well.

Both risk assets have foreboding resistance levels above, however, as well as 50DMAs. The distribution in April-June is bearish, and the recent rallies off lows have been on low volume, so we are maintaining a bearish outlook with long risk hedges skewed for beta. The one asset that got bid today with little overhead resistance is gold, which is in a bullish triangle and looks primed for a breakout through 1250/oz soon.

Philly, Chicago, & Empire employment are all rolling over, and with last month’s abysmal private job gains in context of the census-fueled NFP gain, next month’s NFP data may show some serious underwhelming. Meanwhile, the NAHB/Wells Fargo Home Builders Index rolled over to 17 this month from 22 last month vs 21 consensus, as the first-time homebuyer tax credit expired. The Empire State Manufacturing Index rose to 19.6 in June from 19.1 last month, a tad lower than the median 20.0 estimates. With May’s Manufacturing PMI at 59.7, if the Empire State data is forecasting June’s PMI, then we may get another month or two of PMI > 55, but if this level breaks, we will be watching closer and closer for confirmation of an imminent double-dip.

Lots of talk about the ECRI WLI rolling over (presented below), and well-deserved in our opinion– though not confirming a double-dip, it is definitely indicating a slowdown in growth and the onset of the stimulus hangover.

3mo USD LIBOR is ignoring the recent reversal into risk, as interbank liquidity continues to dry up. These issues are even more magnified in the EURIBOR market. This is not good going forward, and unless there is a roll over in LIBOR spreads, credit will continue to deteriorate and equity will have no choice but to eventually catch up, hard and fast.

If the 10yr yield declines further from here, the flattening curve (3mo doesn’t have much more room to fall) + widening credit spreads (both interbank and corp-Tsy/CP-Tsy) may be a harbinger for future bearish action. If risk appetite spells outflows from Tsys and sends the 10yr yield back up, risk should be bid again and rallies will have legs.

But the sustainability of this whole game seems nil. After all, once rates do start rising (nominal zero floor + sov credit risk as Tsy avg maturity continues to plunge into record issuance), the whole backstopping/guaranteeing of FNM/FRE/related entities paper will be enormously bearish, as the presently artificially low borrowing costs will skyrocket, just as the sov funding costs do as well. The Fed’s Maiden Lane portfolios’ DV01 may be huge and terrible for financial markets, but the IR & duration risk to govt-backed paper will be grossly damaging to the US economy.