The Precise Take – CPI comes out deflationary – can equities shrug off to head higher?

Treasury Analysis:  Yesterday’s 30 Year auction had solid support, allowing the 30 Year T-Bond future to reverse its prior day loss.  The next test will be Monday’s Treasury Int’l Capital report at 9:00 am, which will reveal the holdings of the big name purchasers of US long term debt, then next Thursday’s announcement for the following week’s auctions of Treasuries, which is expected to continue its uptrend and be for a record amount.  The 30 Year looks to be in good shape short term, but we would like to see it take out the 119’08.5 swing high sometime next week. 

The Federal Reserve Bank of New York (FRNY) had already scheduled POMO for the coming Monday and Wednesday prior to the FOMC announcement.  Based on the tentative maturity range, it looks like they will not be buying this week’s supply (3, 10 or 30 Year).  As has occurred each Friday for the last five weeks, the FRNY will be conducting a POMO for Agency securities today.

Time Profile:  The Time Profile for all Agency POMO days that have occurred on Friday since the beginning of the March rally (n=14) has a slightly bullish edge into mid-day and a very strong paint the tape close.  However, for July going forward, the edge becomes bearish in the afternoon, with a tendency for a weak close.  This could be because each of these recent POMO Agency Friday’s has been preceded by a regular POMO day, which tends to have a bearish close on the following day.  Accordingly, because yesterday was not a POMO day, we believe the possibility of a strong close is greater today than the previous five Fridays, even if the day is net down up to that point. 

Trading Today–Putting it all together:  We weigh the markets’ reaction to news as much, if not more so, than the news itself, and have expected CPI to be…

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After the successful 3 Year auction today, the 30 Year (which we follow most closely as a proxy for the long dated Treasuries) sits in a fine position to weather even a tepid 10 Year auction tomorrow; however, with the FOMC Announcement 75 minutes after the 10 Year auction tomorrow, it could easily be overshadowed. 

Another scenario for consideration is that (1) QE is not renewed in the FOMC Announcement tomorrow, which would otherwise be bearish for Treasuries and (2) the 10 Year and 30 Year auctions this week have such strong foreign interest that they avoid a downturn.  With another ~$70-80 B in POMO money set to come into the markets over the next month and another (likely) record breaking set of auctions set for the end of the month, this is risky for Bernanke.  However, nonrenewal of QE and strong auctions this week would send a very confident signal to the Treasury market this week.  Raising the interest rate on excess reserves or hinting at tightening could also help to stem the dangerous advance in equities; however, as we have said before, Bernanke does not want to be seen as putting in the top in equities. 

We don’t envy his position and don’t front run big news.  However, for those with positions on, our continuing thesis is that, one way or another, equities will correct this week and Treasuries will advance (with yields turning down).  For the grand scheme to be a success, we’d like to see the 30 Year close over 119’08.5 resistance this week.  If there is a close under 114’30, the march up in yields will become a threat again.

The POMO auction was strage today, as Zero Hedge reports.  Any bullish trading edge left over from the prior POMO day was expected to disappear by mid-day anyway (and apparently disappeared long before the open today), so we will now guide ourselves by other factors. 

The only leader that did not confirm the equities downturn today was gold, which equity bears will want to see breach support tomorrow.

Overnight, 990.00 support will be the level to watch, with 983.75 to 999.50 unlikely to be breached either way.

The Precise Take – Maintaining strength and looking ahead to Wed’s FOMC Announcement

Yesterday:  We wrote

[W]e would like to see a break of 998.50 early before entering shorts and indeed may fade long this area if buying comes into the ES.  We would also expect longs to come in at the 994.00 to 996.00 area.  If it turns out to be a range day (likely), the downside will be trickier to trade than the upside.  Above, and we don’t get outright bullish until above Globex highs at 1007.75 [corrected from 1007.50].  1010.50 to 1015.25 has very little resistance. 

The ES could not break the overnight high in early trading yesterday and ended up testing Friday’s day-session’s low of 999.50, with a final probe down to test our critical support of 998.50 (low of 998.25).  This area was quickly rejected and breakout shorts were forced to cover into the close.  When a high confluence support area is breached by a point or less and quickly reversed, it is often a clue that the reversal will continue from forced covering as it did yesterday.

Today’s News:  The 3 Year Auction at 1:00 pm will be the one to watch as an indication of long term Treasury interest ahead of the 10 Year (tomorrow) and the 30 Year (Thursday).  As we wrote yesterday,

[A]s we have seen recently, the smaller auctions can go poorly as long as the last longer dated auction of the week goes well.  Therefore, it has more bullish potential for Treasuries (bearish for equities) than vice versa because weakness will be downplayed.  This week is the last holdout for Treasury longs and we expect much volatility into Wednesday and Thursday, though today will likely be quiet.

POMO:  Yesterday and today are days on which the Federal Reserve Bank of New York conducts permanent open market operations (POMO), for which we have developed trading edges with the help of others*.  Yesterday’s price action fit Graph 3 from our Sunday post quite closely after the first hour (see page 2 for the comparison with actual price action).  The tape-painting into the close effect had been diminishing recently with gains concentrated in the preceding afternoon hour, but resurfaced yesterday.  Generally, we were bullish into the afternoon and early trading today, which is what has occurred.  Today’s time profile has a bullish edge into the morning, but turns bearish around mid-day. 

Big Picture:  We don’t have much to add from our Big Picture segment from yesterday’s report regarding the FOMC Announcement and Auctions.  Regarding the leading markets we follow, we wrote:

[The leaders] are not yet pricing in further equity gains this morning.  The EuroYen cross, an important barometer of risk taking is testing its June highs.  A break through resistance would signal expected further gains.  Gold is off its Thursday highs and curiously did not advance on Friday’s gains in equities.  Also, the 30 Year T-Bond is holding support at its July low, but just barely.

Gold and the EuroYen cross finished the day materially lower, with gold bouncing off a 61.8% Fibonacci retracement from its July 29 low, which has held overnight.  Overnight, the EuroYen has lost further ground.  The big winner yesterday, however, was the 30 Year T-Bond future, which formed a bullish engulfing candlestick pattern on the daily chart after testing critical support.  This puts Treasuries in a good position into tomorrow as even a weak 3 Year Auction today will likely not cause the 30 Year to break support.  All in all, the leaders are still not pointing toward new highs in the S&P 500.  Gold will be the likely leader if this pattern reverses, so we’ll watch for a strong move up as an early indication that equities could see another strong run up.

Trading Today:    Putting it all together, we are not expecting a…

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So far, an expected quiet morning with the overnight low of 1000.50 sucessfully defended.  The ES should be able to break a bit higher into the afternoon, especially if it can clear Friday’s market profile point of control at 1010.50, though it will likely back and fill up to that point.  If the low is taken out, we become bearish and will look for shorts, but only after support at 998.50 is taken out.  As we wrote in the morning report, there are a lot of support levels immediately to the downside, so gains will be difficult to hold on to.  To the upside, above 1010.50, and we should be able to reach the 1015.00 day session only R1 resistance point.  New highs are unlikely with gold and the EuroYen in retreat, but possible into tomorrow morning with the POMO effect.

The Precise Take – Quiet news day ahead of jam packed (potentially) watershed week

Friday:  After a strong bullish premarket push up to the 1007 area resistance, the ES retreated a bit , but was able to break through a few minutes after the first hour.  As we updated intraday:

The R1’s were exceeded premarket, but the double top of the last two day’s in the 1,007 to 1,008 area have proved to be the stumbling block.  If the ES cannot exceed by 10:30 am, we would move stops up on any longs and resist taking new longs unless and until the resistance is cleared.  We now become bearish below 1,000 and would look for shorts below that area.

The close was not as strong as the bulls would have liked, but overhead resistance was cleared and we have a clear break of the 1000 level on the long term charts.

Looking ahead this week:  With the 10 Year auction that needs to show strong foreign interest and the FOMC Announcement on Wednesday, and 30 Year auction on Thursday, the markets will be looking to tomorrow’s 3 year auction at 1:00 pm for clues.  However, as we have seen recently, the smaller auctions can go poorly as long as the last longer dated auction of the week goes well.  Therefore, it has more bullish potential for Treasuries (bearish for equities) than vice versa because weakness will be downplayed.  This week is the last holdout for Treasury longs and we expect much volatility into Wednesday and Thursday, though today will likely be quiet.

POMO:  Today and tomorrow are days on which the Federal Reserve Bank of New York conducts permanent open market operations (POMO), for which we have developed trading edges with the help of others.  See our overnight post that updates the time profiles for today and tomorrow.  In short, the paint the tape tendency is diminishing as we’re seeing many of the day’s gains finished by 3:30 pm on POMO days in this July rally.  Also, the first hour today could prove tricky as we have some conflicting information.  We would look for a break of 1007.75 to the upside or 999.50 to the downside in the first 15 minutes to see if there will be a directional edge for the morning.  If we go down initially, longs may want to hold out, looking for a low into the hour that closes at 1:30 pm.  For the July rally only (n=5), there is a very strong tendency on the second day of a back to back POMO set to see a strong open and continued gains until about mid-day, after which we have been getting very weak closes.

Big Picture:  In the ongoing saga of Treasuries vs. equities, we feel this week is the last holdout for the Treasury longs and that it’s do or die for the Fed.  As we’ve been writing, the potential disaster that awaits with long term yields breaking to new highs is much greater than a stock market correction.  However, institutional sentiment seems to be that the Fed will simply let QE expire when it runs out of money or time (six months from announcement on March 18 09) in September.  The FOMC could wait until the next meeting in about six weeks to renew, but yields will likely have gotten away from Bernanke by then, and a hinting of a rate increase (which could correct yields) is too politically dangerous for Bernanke, who would not want to be seen as having single handedly put in the last stock market top.  Accordingly, while we still find it likely that QE will be renewed on Wednesday, we must prepare for a Fed that stands idly by as the Treasury market disintegrates and for the monster rally in equities that could accompany.  Until Wednesday, we will tread carefully, but we expect to have an answer by Thursday on where we are headed over the next few months.

The leaders are not yet pricing in further equity gains this morning.  The EuroYen cross, an important barometer of risk taking is testing its June highs.  A break through resistance would signal expected further gains.  Gold is off its Thursday highs and curiously did not advance on Friday’s gains in equities.  Also, the 30 Year T-Bond is holding support at its July low, but just barely.

The Big Rally:  We hinted at a massive equities rally that could continue from this week’s news.  There was very little transacted volume in the markets from the area of 1000 to 1200 on the S&P 500, which takes one form of resistance off the table.  Also, as our friend Billy O’Nair has researched, the S&P is now 15% above its 200 day moving average, which has historically led to further gains in the following three months.  In this environment, overbought and oversold are largely irrelevant and mean reversion strategies are indeed getting hammered.  A note of caution, however.  The only time the S&P 500 has been 15% over its 200 day MA in the late summer or fall was the second week of August, 1987.  Go to your charts if you don’t recall what happened a few months later.  The time of year is critical, because, as we have studied, M2 volatility (at historic highs now) can exacerbate corrections in equities that become self-feeding.  If we get a reversal this week, we are very skeptical about the ability of equities to break to meaningful new highs in the subsequent weeks and will be on alert for crash signals into October.  We’ll also throw out that the NFP Friday was a spike high and NFP have been reversal days this year, while FOMC days tend to be trend continuation days.  Again, we need to wait until Thursday for confirmation of everything.

Trading Today:    As we write, the ES is entering our intraday bearish area at 1001.50.  However, we would like to see a break of 998.50 early before entering shorts and indeed may fade long this area if buying comes into the ES.  We would also expect longs to come in at the 994.00 to 996.00 area.  If it turns out to be a range day (likely), the downside will be trickier …

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Refer to other posts under the POMO tag cloud 5for more information on POMO. 

Not much time here, but we will have more in tomorrow’s morning report.  For those that are planning for tomorrow’s action, please consider the below.  Also, ignore any dates in the “x” axis of the graphs.

Graph1:   The tape-the-paint tendency has been fading since the July 09 min-rally, in favor of the 2:30 to 3:30 pm hour.  Also, note the strong opening hours.  Even though the auctions have not yet occurred (they start at 10:30 am), could this be frontrunning as people are catching on?  Perhaps, because this opening bullish edge completely disappears for non-POMO days in the same time period (not shown).  Measuring the edge from the July rally forward appears to be important, but it necessarily reduces the sample size.

 Graph 2:  This covers each of the days from July to present for which there has been an Agency POMO on the preceding day (all were Mondays–important–and have enjoyed great strength.  Note too, that Monday’s are usually quiet news days (as is tomorrow).  Unfortunately, sample size is necessarily small.

Graph 3:  This is the one negative factor for tomorrow morning because, going back to the beginning of POMO (Mar 25 09), a POMO day following a POMO (Agency) day has had a tough opening hour.  We’ll filter our bias based on the price relative to Friday’s close 1-2 hrs pre-open.

Graph 4: This is this Tuesday’s Time Profile because it is a POMO day following another POMO day.  Note the tendency for a strong first hour, but negative performance after 1:30 pm.

Always remember the following:  The “edge” is an evolving target.  You would need to take every trade on a given edge to produce the graphed results.  Because the edges are often discovered with 20/20 hindsight, this is not possible.  All we are alerting to here is that traders might want to be more receptive to certain trends and possible reversals in certain periods of time.

1010.50 to 999.50 is our projected overnight range, assuming no major developments, and the opening price of tomorrow’s day session relative to these numbers and also Fri’s settlement of 1006.50 will be important to our projection for the day.

We will have much more tomorrow, including an analysis of whether or not the amount of buyback on POMO’s  by the FRNY from primary dealers of the dealers’ inventory acquired at previous Treasury auctions has any trading edge (hint: it appears to).  Thanks to Zero Hedge for his painstaking work on this over the weekend.  Thanks to the members of the Value in Time Group for their invaluable contributions.

The Precise Take – NFP exceeds expectations and leads equities higher

Yesterday:  Bulls should have been able to extend the overnight gains and, instead, sold off sharply on the premarket push to just shy of the old November 5 08 high of 1,008.50.  In many respects, yesterday was a very close cousin to the day prior until about noon, when it failed to rebound off the 991 support area and, instead, made lower lows into the afternoon.  As we updated intraday

Recall that yesterday’s point of control at 991.00 had strong support and bulls were able to reverse price from it.  A break below signals a reversal from the bullish sentiment that has carried the week and has seen the major points of control hold. 

We didn’t get a material break below 991 as 990.00 was the low, and the trend of respecting higher value areas remained intact.

Big picture:  The FRNY’s permanent open market operations (POMO) have been gaining momentum in the news lately—nothing in the mainstream media that we have found, but increasingly, astute independent economists and bloggers are focusing attention on the operations.  Chris Martenson reports:  

And now it turns out that 47% (!) of the bonds that were taken by the primary dealers in [last week’s 7 Year] auction have been quietly bought by the Fed and permanently secreted to its balance sheet.

Recall the non-primary dealer interest was low in the 2 Year and 5 Year and that (we believe) demand was merely being saved for the 7 Year.  In what can be described only as a pyramid scheme, it is clear that the primary dealers are being allowed to offload their recent Treasury purchases through POMO operations, sometimes on the settlement date, meaning the debt was not in their hands for a full 24 hours.  As Brian Brenton writes:

It makes you wonder if the Fed is not encouraging primary dealer participation in these auctions by making it abundantly clear that the Fed will absorb a sizeable portion of their inventory quickly, while still assuring dealer profits. This is about as close as it gets to the Fed lending directly to the Treasury, without actually doing it.

It was the March 18 09 FOMC Announcement that paved the way for POMO, allowing $300 M and six months for the operations.  It is increasingly clear that POMO is a necessary evil to maintain Treasury auctions.  The ramp job in equities is a side effect of the dealers leveraging that capital and flooding the markets with it, and must irritate Bernanke to no end as higher equities are themselves reducing foreign interest in the Treasury auctions and causing long term yields to become dangerously close to reaching levels that, once broken, will end up spiraling out of control. 

We updated yesterday,

As we speculated earlier in the week, the FRNY has, for the third week in a row, announced on Thursday that the next day (Friday) it will be conducting permanent open market operations on Agency securities (Fannie/Freddie).  The amount of Agency POMO is usually about $1.5B, less than regular POMO.  However, this will make an unprecedented five days in a row (including Monday and Tuesday’s scheduled operations) of liquidity dissemination that can be leveraged 100 times or more in the markets.  With $7.5 B yesterday, $7.00 B today, we could easily see $30 B of leveragable capital hit the markets by Tuesday.  Clearly, the FRNY is coming out with guns blazing and we should have a volatile week into Wednesday’s FOMC Announcement. 

In light of the Martenson and Brenton articles, this 5 day POMO frenzy could be clearing the decks at the primary dealers for next week’s 10 and 30 year auctions on Tuesday and Wednesday.  Bernanke is in a very tight spot as (1) he will likely need to announce renewal or non-renewal of the quantitative easing program (POMO), (2) he does not want the next top in equities to be too close to the FOMC announcement as he is seeking re-nomination, (3) if we don’t get an equities correction soon to relieve pressure on long term yields, he could instead preside over a major Treasury market dislocation.  Things, in general, are looking up for Larry Summers, who would be happy to have his job, and we would not be surprised if this historic rally that began in July were part of a Bernanke hit job—forcing him to play his hand at the upcoming FOMC meeting.

On to NFP:  We set forth four scenarios yesterday, and it looks like unlikely #3 is now playing out. 

 (1) Equities and bonds both finally correct off a poor NFP report tomorrow.

(2) NFP doesn’t generate much volatility (like last month) and both equities and bonds tread water into the FOMC Announcement.

(3) Over the next few days, there is another material spurt up in equities with a return in the 30 Year bond to lows in the 112 area, and then a double bottom in bonds into the FOMC Announcement that then sees equities correct and bonds begin a multi-week rally.  This requires a move of 4 ½ big bond points and, for this to occur, we need to see a strong move through support at 114’30 (swing low) from tomorrow’s NFP report (which would have to greatly exceed expectations), with the FOMC Announcement generating the bullish news for bonds (and bearish for equities).  If Bernanke wants to kill the stock rally, all he has to do is hint at tightening.

 (4) Equities continue to break to new highs after the FOMC Announcement, long term yields break to new highs above 5%, and gold priced in US Dollars breaks 1,000 convincingly.

Trading Today:  As we write, NFP has greatly exceeded expectations and, as we would expect, equities and long term yields are materially higher, with the 30 year having tanked.  The ES has found some resistance at the daily R1s, but should be able break to material new highs if it can clear in early market action.  We’re not outright bearish unless and until the market corrects back down to 994.25.  A word of warning to the bulls is that these premarket spike highs often presage…

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As we speculated earlier in the week, the FRNY has, for the third week in a row, announced on Thursday that the next day (Friday) it will be conducting permanent open market operations on Agency securities (Fannie/Freddie).  The amount of Agency POMO is usually about $1.5B, less than regular POMO.  However, this will make an unprecedented five days in a row (including Monday and Tuesday’s scheduled operations) of liquidity dissemination that can be leveraged 100 times or more in the markets.  With $7.5 B yesterday, $7.00 B today, we could easily see $30 B of leveragable capital hit the markets by Tuesday.  Clearly, the FRNY is coming out with guns blazing and we should have a volatile week into Wednesday’s FOMC Announcement.  If ever there were a time for short term methods, it’s now.

The Precise Take – Markets positioning ahead of crucial five day stretch

Yesterday:  Examining yesterday’s price action in the ES, we had an early test of the next lower [market profile] value area and bounced within a tick of its point of control at 991.00 (green line by yesterday’s low in the support and resistance chart on page 3).   This area was rejected and the ES was able to test its opening area into the late afternoon, but then reverted to the 998.50 point of control.  When markets continue to reject lower value areas in favor of higher ones, this is bullish.  The only thing bearish was the inability of the ES to rally in the close after the $7.248 B in permanent open market operations (POMO) capital that had been released by the Federal Reserve Bank of New York (FRNY) earlier in the day.  Yesterday, we wrote

“With equities overextended, having had no meaningful pullback since the July rally began, the close today will be an excellent test of whether or not it can continue, or whether the continued capital infusions by the FRNY are in vain (at least temporarily).”

Big picture:  The FRNY announced the upcoming schedule for its POMO operations and there are now two scheduled next week for Monday and Tuesday, sandwiched conveniently between the Employment Situation (NFP) report tomorrow and Wednesday’s FOMC announcement.  In addition, we have the closely watched 10 year and 30 year auctions on Tuesday and Wednesday, respectively.  Demand on the long end of the curve is most important to the Treasury as it is trying to average up the maturity of its obligations.  Tepid to poor demand can send yields soaring, which it wants to avoid at all costs.

The next five days of trading into next Wednesday are exceptionally important and will probably decide the fate of this rally.  Though we lean strongly toward an equities correction to keep long term yields in check (temporarily), the FRNY is shouting loudly that, bonds be damned, it will get its S&P 1200.  Can we have both?  We don’t see how.  So, we see four possibilities:

(1) Equities and bonds both finally correct off a poor NFP report tomorrow.

(2) NFP doesn’t generate much volatility (like last month) and both equities and bonds tread water into the FOMC Announcement.

(3) Over the next few days, there is another material spurt up in equities with a return in the 30 Year bond to lows in the 112 area, and then a double bottom in bonds into the FOMC Announcement that then sees equities correct and bonds begin a multi-week rally.  This requires a move of 4 ½ big bond points and, for this to occur, we need to see a strong move through support at 114’30 (swing low) from tomorrow’s NFP report (which would have to greatly exceed expectations), with the FOMC Announcement generating the bullish news for bonds (and bearish for equities).  If Bernanke wants to kill the stock rally, all he has to do is hint at tightening.

 (4) Equities continue to break to new highs after the FOMC Announcement, long term yields break to new highs above 5%, and gold priced in US Dollars breaks 1,000 convincingly.

With 4 so damaging to the Treasury’s ability to issue long term debt and posing the risk of long term yields spiraling out of control, it’s by far the lowest on our probability scale.  1 and 2 are about equal, and 3 a bit lower.

Trading Today:  As we write, the ES has advanced to the daily R1’s and made new highs, nearly reaching our long term 1008.50 upside target.  However, it is in a potential reversal area, which bulls will need to…

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The Precise Take – Rally extends with bullish expectations for Friday’s employment report

We could republish much of yesterday’s column in today’s report because not much has changed.  As we noted post-close yesterday, the daily market profile points of control at 998.50 for Monday and Tuesday are identical and, as expected have served as support overnight (low 999.00). 

Today and Thursday are POMO days, or those days on which the Federal Reserve Bank of New York conducts permanent open market operations and floods large institutions with leveragable capital.  Though these days usually have a low in the hour closing at 1:30 pm EDT and a tape painting effect, the second day of a back to back POMO set does not necessarily have a bullish or bearish edge.  Also note that we can have a paint the tape close on a net down day.  With equities overextended, having had no meaningful pullback since the July rally began, the close today will be an excellent test of whether or not it can continue, or whether the continued capital infusions by the FRNY are in vain (at least temporarily). 

As we write, the Challenger jobs report came a bit worse than expectations and the ADP Employment report came in good as expected, which pushes up expectations for Friday’s Employment Situation report on non-farm payrolls (NFP).  As shown on the chart on page 2, NFP days are frequently volatile (with the notable exception of last month’s) and tend to occur around turning points in the market.  Unless we have an extraordinary correction into Friday morning, the likelihood is that the turning point will be to the downside and will coincide with the needed support next week in Treasuries (at the expense of equities).  Another possible situation is a minor correction into Friday morning with a retest of highs that day resulting in a double top formation.  As the 30 year and 10 year are testing strong support now, we posit this is the more likely situation, which would make the overnight high of 1006.50 a temporary high.  For confirmation, however, the ES needs to close below 991.00 and ideally get below 996.00 early.  Otherwise, we will likely see new highs into early Friday.

Today is also an important day for the Treasury markets, as the department will release its funding intentions for the next quarter and the amounts of the all-important Treasury auctions in the 3, 10 and 30 year scheduled for next week.  The trend has been for the amounts to increase and, if they do not, we would take this as a sign that the Treasury is a bit worried about finding support.  However, this would be short term bullish for Treasuries and, with the 30 and 10 year at support, we would not be surprised for either this to occur or for equities to correct, either one of which would put in a needed temporary bottom in Treasuries.

In the ES, there is much overhead resistance into 1,013.50.  So, if we were to get a strong directional day up, it would need to be…

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