3:43 pm EDT:  as the new high just prior to the critical 3:30 pm time failed to gain breakout momentum and was likely a bull trap.  We’re sitting out for the balance of the day.

12:26 pm EDT:  The ES is hanging around quite comfortably in the middle to upper daily range.  We would be inclined to expect the range to hold but for the $2.1 B permanent open market operations in Agency securities the FRNY conducted this morning and the high correlation with a bullish close.  The price at 3:30 pm will be key for us whether or not we will break the upper range.  That price for us is the same 986.00 from the earlier post.  Below that and we don’t think enough momentum can develop to push through highs.  We would be surprised to see a break below early morning lows and yesterday’s settlement of 977.75, but 973 is still strong support and we expect to close above it, even if price breaks through it intraday. 

The 10 and 30 Year Treasury futures have posted huge gains today as expected, and we would be surprised to see that momentum squander by new highs in equities early next week.  Next week we have two FRNY POMO days back to back Wednesday and Thursday.  Based on this we would expect a decline into Tuesday, with Tuesday 3:30 pm or Wednesday 1:30 pm +/- one hour to be the best time to initiate new longs or close shorts.  As we stated in the morning report, we will be thinking this through and reporting on it more thoroughly over the weekend, so this is an unofficial caveat. 

As an aside, to answer a reader’s comment why we have not once mentioned the US Dollar once this week despite its volatile attention-drawing activity, it is because we believe it is being lead by Treasuries and is not supplying any leading information.  Were M2 NSA trending up with the Dollar down, we would give it more importance as the depreciation through monetization theme would be present.

10:15 am EDT:  We were bullish only above 991.00, yesterday’s highest value point of control and we got a clear rejection of that level, though early morning lows are providing decent support.  Volatile action so far can make for a difficult day and, with volume above average, we think the early range will break.  We would not be surprised to see a test of the long term 973 point of control and a bounce to test VWAP into lunch, test of lows, with a strong late day close.  In this scenario, 985-986 should contain price right now and begin another down leg.  Above 986.00, and we have to consider that an upside breakout is more likely.  Below 970 and bulls can only hope for a daily close above 973.

The Precise Take – 7 Year Auction buys time for bonds as equities finish record strong month

We were at a crossroads this week contemplating that our primary theory of the markets, the dominant theme of which is the interplay between US Treasuries and equities, was no longer or was never correct.  After yesterday’s 7 Year auction, we are more convinced than ever that this is the case, and that the markets are caught in a tug of war between Bernanke’s Federal Reserve (FR) in Washington attempting to keep down long term interest rates and Dudley’s FR Bank in New York (FRNY) trying to keep equities on a tear for the large member banks.  The administration prefers both as they help keep public opinion from swelling to be too negative and hurting the chances of pursuing its agenda (which is already in danger). 

The entire week’s price action in the ES with all its zigs and zags could have been forecast in two scenarios as early as last Friday, with the correct scenario being known Tuesday afternoon.  It involves the varying dynamics of (1) the paint-the-tape closes induced by permanent open market operations (POMO) by the FRNY, (2) the Treasury-supportive signals broadcast early in the week in the EuroYen forex cross as well as the gold and Treasury futures markets (to this we note that the FRNY contains massive gold holdings as well as foreign currency reserves in exactly two currencies—the Euro and the Yen), (3) declining M2 non-seasonally adjusted which has a strong historical tendency to increase volatility, (4) the record Treasury auctions that needed to show enough demand to prevent a dangerous rise in yields, and (5) the need for equities to close the month on a high note.  It was as to 4 and 5 where we went slightly askew because 5, above, was the priority (equities needed to post as much gain as possible end of month) and, as to 4, we had hypothesized that Treasuries needed to rally at the expense of equities whereas they actually only needed to tread water until the eventual equities takes place. 

As an aside, M2 NSA as reported yesterday continues to shrink, thus increasing the likelihood of continued or increasing volatility.  A reader correctly commented yesterday that the FRNY’s POMO forays are money printing.  However, this increase in the monetary base is not working its way into M2 for whatever reason, and it is M2 that has the most effect on the economy and not M1 or M0 (the monetary base).  Historically, the Fed has had little control over M2, but we suspect that, with its increased powers, the Fed has more control than previously and may be intentionally counteracting the money printing of the NYFR.

To further support the priority of a strong equities close, the FRNY announced yesterday it would conduct POMO for Agency securities (Fannie/Freddie) today, and we commented pre-auction yesterday:

After $3 B yesterday and $6.5 B today, another (probable) $1.5 – $3 B tomorrow [Friday] in Fed funny money sent to banks that can be leveraged 100x or more should give the bears pause, especially into month end (tomorrow).  Our question is, what is the NYFR so worried about?  The contrarian in us would believe it’s to overcome a weak GDP report tomorrow and/or a very strong 7 year auction today.

That the 2 and 5 year auctions did not send the 10 and 30 Year futures down by 3 or 4 big points into Wednesday afternoon was evidence enough that demand was being saved for the 7 Year.  As we updated yesterday post-auction, “Bernanke has probably bought himself two weeks of long term yield control until the August 12 10 year auction is conducted.”  We will by tying all this together in a more comprehensive report over the weekend that includes possible scenarios for the next couple of weeks.  Register free here to receive this and other updates.

The time profile for the day after a POMO day (as was yesterday) that is also a POMO (A) (n=5 since May 09) shows a strong tendency for the ES to head down and bottom in the first hour, with no clear further bias until the close, which shows a strongly bullish bias.

As we write, GDP has clearly disappointed as expected; however, equities are ensured a good close as we find a close below 973 unlikely.  In light of the new comprehensive analysis above, we are removing our 1008 target and suspect…

Continue reading here.

1:09 pm EDT:  What we suspected would happen yesterday happened today.  Though the bid to cover ratio at 2.63 could have been better, non-primary dealer interest (the true guage of an auction’s success) was ~64% (50% is usually considered strong). 

Were the ES in the mid 970′s now, we would be very bearish and calling for a double top.  However, it looks like equities will be able to remain afloat, especially with the aforementioned POMO(A) funny money drop into the markets tomorrow. 

In the meantime, Bernanke has probably bought himself two weeks of long term yield control until the August 12 10 year auction is conducted. 

Everyone’s happy…for now.

New York Fed Announces July 31 Outright Agency Coupon Purchase

After $3 B yesterday and $6.5 B today, another (probable) $1.5 – $3 B tomorrow in Fed funny money sent to banks that can be leveraged 100x or more should give the bears pause, especially into month end (tomorrow).

Our question is, what is the NYFR so worried about?  The contrarion in us would believe it’s to overcome a weak GDP report tomorrow and/or a very strong 7 year auction today.

If Bernanke manages to keep long term yields down after Geithner’s Lollapallooza in Treasuries while the FRNY keeps the stock market juiced into tomorrow, we will personally pin the Precision Award for Masterful Manipulation on Bernanke, Geithner and Dudley.

11:27 am EDT:  The ES has not looked back as it has headed all the way past day-session-only R3 and weekly R1.  Globex daily R3 at 995.75 is all that remains until confluence of weekly R2 and the old Nov 5 08 high at 1008.50 to 1008.75.  Again, we’re not fading short at these levels, but would wait for a pullback to 988 for new longs as we’re unlikely to post meaningful gains for a while.  We only get intraday bearish below 982 now.   

Today’s POMO auction, for what it’s worth (though we stipulated by itself it would not give a bullish edge) was for $6.5 B, larger than yesterday’s $3 B.  Assuming equities can hold on to their gains through the 7 Year auction at 1:00 pm, we should get additional gains into the close because of momentum alone.

Longer term:  Below is a gold chart that shows the consolidating wedge developing off 61.8% retracements (marked 1, 2, 3 and 4?).  The last would see a rise to about 947 should it occur, then reversal down again.  In this highly technical and standout pattern, a breakout will be watched closely as a signal to the direction of the markets and economy.  To the upside (bullish for equities), gold has the potential to finally move beyond the 1,000 level.  To the downside (bearish for equities), we see 800 as a target.

The Precise Take – New highs overnight; 7 Year Auction key today

Our ongoing hypothesis has been that the ability of the Treasury to fund the massive deficit spending of the US government is the key factor to watch this week to anticipate future market direction.  If the auctions were a great success, we would expect Treasuries to compete with equities for dollars and for equities to decline, with the world betting on deflation rather than inflation.  If the auctions were unsuccessful, we would expect equities to be more attractive and for long term Treasury yields to climb in order to make Treasuries more competitive (with the world betting on inflation).  An outright failure (nearly impossible as Karl Denninger notes because primary dealers are required to buy what others do not) would have disastrous consequences and would be largely unpredictable as to consequences.  We also believe that higher yields are Bernanke’s greatest threat because they exacerbate the upcoming problems with prime and Alt-A mortgages and commercial real estate loans that will need to be financed over the coming 18 months—a bigger problem than another leg down in the stock market.

We have looked to gold futures, long term Treasury futures and the EuroYen forex cross for signals as to how these auctions might proceed.  So far, they have signaled auction success, which does not track the reality of the poor showing of the 2 and 5 Year auctions Tuesday and Wednesday of this week.  As we updated yesterday, “though long term yields shot up on the announcement as expected, the ES has headed lower into support.  Support should hold and allow the ES to head higher and break resistance at 973.00.”  This did eventually come to pass, but the 30 year yield closed right back where it was before the auction. 

Accordingly, our primary scenario for the ES which has been on track so far (down into the afternoon yesterday, strong close, test of highs into Thursday morning, then lower into Friday close) is unfolding for reasons that violate our premises.  So, we are losing confidence in the scenario and are willing to put a 50/50 chance that the ES will now hit its next upside target at 1008 as early as tomorrow (Friday). Our market leaders are not as equity bearish as they were into the morning, so it is possible they were simply wrong a few days ago.  We will closely watch the 7 Year auction at 1:00 pm today and GDP tomorrow at 8:30 am.  A great auction and bad GDP can still send equities down, be we are not holding our breath now for that.  Today is another POMO day, and as we reported yesterday, the second POMO day of a back to back set does not have a bullish edge (nor does it have a bearish one).  See page 2.

As we write, the ES has shot up precisely to monthly R2 at 986.50 on the weekly jobless report.  Shorts will want this to be…

Continue reading here.

1:12 pm EDT:  In the auction, bid to cover ratio at 1.92 and foreign interest at about 35% is disappointing for Treasuries.  And, though long term yields shot up on the announcement as expected, the ES has headed lower into support.  Support should hold and allow the ES to head higher and break resistance at 973.00.  If the ES makes new lows and gets below 865, we suspect there is something else going on and must conclude that today’s auction was not as important as we thought.  Perhaps tomorrow’s 7 Yr will be the real shocker.  Still have Beige Book at 2:00 pm and the POMO close to consider.

11:19 am EDT:  Despite the bearishness being broadcast by the above leading instruments, the ES refuses to die.  Again, the 1:00 pm EDT 5 Yr auction is key today, though the 2:00 pm Beige Book will give insight into the data the Fed is pondering. 

On a typical POMO day such as today, we see a dip into the 1:30 pm hour before a paint-the-tape close.  As we said in this morning’s report, the key for the bears is to keep the ES under 973.00 before the final tape-painting hour (45 min) begins at 3:30 pm.  Above, and the bulls have a chance to break to new highs. 

So far, the day has been a VWAP oscillation day, but that will likely change this afternoon.