Inside Markets — Stalled

Recent yen weakness in the aftermath of the BOJ’s first rate hike in 17 years and dovish tone from Fed Chair Powell is a concerning development.  Also note the BOJ removed all major unconventional easing measures (NIRP, risk asset purchase programs and YCC) but markets expect the central bank will stick to strategic, gradual policy normalization because the economy is seen to be vulnerable to rapid rate hikes following the prolonged monetary easing.  A BOJ that falls too far behind the curve could lead to further yen depreciation with increased FX volatility often resulting in heightened financial system risk. Today’s intervention rhetoric from the MOF takes the yen off a 34-year low, but the risk of further near-term depreciation remains. This 34-year low has been tested three times in the last ~18 months and sustained levels north of ~153 look like a breakdown.

The Fed communicates everything in advance but usually in vague terms.  At last week’s press conference, Powell indicated it would ‘be appropriate to slow the pace of balance sheet runoff fairly soon.’  In Fedspeak, this means they could decide to cut the pace of Treasury runoff at the May 1 meeting with implementation to begin mid-month. This is one of the fundamental drivers behind our outlook for lower yields.  In the near-term, we look for 10-year yields to decline to ~3.93% before a pause to reassess.

The rally in crowded momentum-driven benchmarks like the NYSE FANG+ Index (NYFANG) and Nasdaq 100 (NDX) have stalled over the last ~2 weeks.  Those two indices are holding above key technical support defined at ~9650 and ~17775 respectively.  A break below those levels opens the door for a pullback in the 5-7% range.

A technical break in the aforementioned indices could be healthy consolidation, the start of a correction or the result of rotation into cyclically-sensitive markets. The cyclical rotation scenario seems the least plausible given highly restrictive real yields, shape of the yield curve and negative money supply growth. Our favorite cyclical proxy for this market is the RTY because it remains contained within a two-year trading range and a sustained break above that range is an easy-to-identify ‘stop in’ level.  At 2099, the RTY is currently testing the upper end of that 2-year range. A sustained break above ~2100 may signal the start of a global manufacturing cycle and an opportunity for a significant catch up trade in small-cap stocks.  The currently RTY trades at a rare 12-month forward multiple discount to the SPX and the performance differential since November ’21 is the widest in history.