A lot of people commented on the correlation between the USD with equities today (including us), but ultimately, the inverse correlation is still holding now that we have an equities reversal.  The USD is heavily driven by interest rates, and earlier this week, we wrote that we expected interest rates to be the next shock to this rally.  It looks like that’s what happened today.  Long term Treasuries have been sold all week…maybe by Japan…who knows.  But the 30 year went from 4.194% to 4.439% since Monday (much of it this morning), which is a large move.  This not only spooks existing USD shorts, but warns of eventual Fed tightening, which the Fed itself has been indirectly hinting at as well recently. 

 

It’s a bit ironic that the appearance of a stronger US economy (in the form of an improving employment situation) spikes interest rates higher, which in turn brings down equities.  A healthy equities bull market can shrug off a Fed rate hike after a day or two, but now, market participants are speculating about the mere possibility of the eventual tightening.  This is probably one reason why it takes a lot to start a new bull market–because the various forms of accomodation (including low rates and fiscal stimulus) have to be removed strategically and can easily cause pullbacks in the stock market, even if the overall economy is improving.  The central planners have proven less than adept at inflection points before, so caution is warranted here.  And, as we wrote this morning, liquidity and credit outside the banks (in the general economy) remains poor.

 

Much as a large trader will dynamically sample supply and demand at support or resistance with large orders to see if other traders will bite, the Fed, in various ways (yesterday’s tri party repo and speeches by “dissenting” Fed personnel this week), is attempting to judge the markets’ reaction to removing accomodation.  Better to do this at highs than lows.  The signal so far is that it’s a bit soon, and hopefully (for the bulls anyway), the Fed will back off a bit.

 

Bottom line:  with the USD at strong resistance and long term Treasuries extremely oversold, there’s a decent possibility of an equities comeback early next week prior to the 10 Year auction on Wednesday.  However, we’re not as opptomistic about material new highs as we were earlier in the week.  Action near the close today will be important.