The Coming Week: New Lessons On The Rally’s Health

Part 1: Daily Breakdown

*Top Market Movers From Prior Week:

  • Rising Perceived Risk of QE Cutback
  • New Evidence of Struggling China Recovery

*Lessons Learned For The Coming Week And Beyond


The prior week was the first down week since mid-April for the US and Europe, and the first real weekly decline in Japan since November 2012.


Monday: Asia, Europe Up On US Performance Friday, Weak JPY, US Down On Further Hawkish Comments


Asian indexes mixed mostly higher. The Nikkei again hits new highs due to continued declines in the JPY and increased optimism after the government upped its assessment of the economy for the first time in two months. Adding to the good mood:

  • Signs of an improving U.S. economy and Wall Street’s record closing high on Friday.
  • A Nikkei report that Japan and India are expected to agree to resume talks toward a civilian nuclear cooperation deal at their summit meeting this month. Manufacturers of nuclear reactors benefited on the report.

Otherwise there was no news out of Asia or elsewhere on Monday and much of Europe had a bank holiday.

European shares also hit new five year highs on follow through effect from the strong US and Japan closes. Meanwhile EU crisis complacency is alive and well, as yields for Italy and Slovenia  fell to lows for the year. Key for Slovenia is to maintain its A- S&P credit rating, which allows its banks to pledge their government bonds as collateral

US indexes were overall flat to slightly lower on hawkish comments from the usually dovish FOMC member Charles Evans renewed fears of coming reductions in bond purchases that have fueled the long stock market rally despite the absence of supporting fundamentals to justify all-time highs.



Tuesday: Caution And Speculation On Fed QE Tapering Dominates Trade


Asian and European indexes were mixed on caution ahead of Fed Chairman Bernanke’s testimony to Congress. His appearance was expected to clarify whether hints about the mere possibility of cutting back on QE are true. Thus it was expected to be the event

US indexes were higher due to (what else?) dovish comments from Fed regional presidents Dudley and Bullard. While they didn’t specifically deny the possibility of some kind of curtailment, they made clear that QE is far from done.

In sum, indexes moving on sentiment about whether the Fed will or won’t materially reduce QE in the coming months.


Wednesday: European And US Indexes Diverge On Timing Difference


Asia was mostly higher, with upbeat BoJ comments fueling Japan shares and those related to them. The central bank kept rates steady, but upgraded its outlook for Japan.

Europe and the US had completely different closes. Europe ended firmly higher, the US firmly lower, all due to a matter timing.

Here’s how it went.


  • 10:00 AM EST (3pm GMT), Ben Bernanke testified before the Joint Economic Committee of Congress.  He emphasized that premature tightening or tapering risked slowing or killing the economic recovery. That was all that Europe heard while its stock markets were still open. European traders took this to mean that there were no imminent plans to cut back on QE. That equities – supportive consensus caused European indexes to close higher.
  • However during the Q&A session that followed, while European traders were heading home, Bernanke reversed himself, saying that the Fed in fact could taper bond purchases in the next few meetings if the economy improved enough.  While that might seem obvious, markets interpreted it as a very intentional hint that his earlier remarks were quite subject to change. That had traders slamming the sell button, and markets headed lower for the rest of the day.
  • At 2:00 PM EST (7 PM GMT), the Fed released the minutes from its latest Federal Open Market Committee (FOMC) meeting. Tweeted Deutsche Bank’s Joe LaVorgna “FOMC minutes show a willingness to taper asset purchases this year,”…We expect the taper will begin in either late Q3 or early Q4.”

So in fact a reduction in QE is on the menu later this year, as long as there is no surprise contraction in the US economy, and that brought a predictable response from US markets

All US indexes ended firmly lower, with the S&P 500 1% down. The USD soared. Even if the Fed does little, Bernanke confirmed that the Fed is heading towards tightening, while the other central banks are steady or heading to easing. Like stocks, currency trends are profoundly influenced by expectations in rate changes, but in opposite ways. Stocks drop on rate hike expectations, whereas currencies rise when their central bank goes into tightening mode


Thursday: All Regions Lower On Bernanke Remarks


Not surprisingly, Asian and European indexes plunged, catching up to the newly reinforced perception that QE 3 isn’t infinite, and may well be cut back in the coming months if the US recovery stays on course. That’s a big “if” but the mere chance of a cutback in stimulus is a game changer. Until the past few weeks, there was no end in sight to QE and Bernanke had indicated the Fed could ease further if needed.

Asia and Europe were down overall 1-2%, with the Nikkei power-diving over 7%.

Of course the EURUSD fell hard on this news as it reinforced the notion that the Fed is tightening relative to the ECB. As we cover in depth in our award winning book, changing expectations on interest rates are a prime driver of currency prices.

Also weighing on markets:

Weaker than expected Chinese manufacturing data exacerbated these moves, but was secondary in influence to Bernanke’s remarks. Of course the mechanics are a bit more complex. Bernanke’s remarks caused a 10bp jump in US Treasury Note yields, which in turn caused a JGB yields to gap higher, and that caused a selloff in the Nikkei. The rising fear upped demand for the JPY, which continues to respond as the ultimate safe haven in times of fear. That’s a delicious bit of irony given the JPY’s likely long term fate, but that’s how currency markets behave these days.


Euro-zone PMIs, while slightly better than expected, continued to show contraction in the region, albeit at a decelerating pace.



US indexes closed only modestly lower, as they’d already absorbed the news of possible QE cuts a day earlier. In fact, they recovered most of their early losses1% – plus losses as the usual buy the dip mentality kicked in.


Friday: Overall Mixed To Lower On Continued Negativity From Fed, China


After Thursday’s -7% bloodbath, the Nikkei bounced back almost 1% and other Asian indexes were mixed. The main cause for the pullback was the news that the Fed may indeed pare back QE. That caused US 10 year bonds yields to spike, which their Japanese counterparts to do the same, and scared Japanese stock investors. The big ramification was that it raised questions about the sustainability of the Japan rally and the credibility of Japan’s radical stimulus policies (aka Abenomics). See Part 2 for details on these questions and possible outcomes.

European indexes closed mixed but overall lower, again mostly due to concerns about Fed QE cutbacks that could leave stocks prices to be more dependent on traditional economic growth and earnings metrics. It’s no surprise that brought continued selloff as these have not been inspiring in recent years. It’s widely understood that stimulus has kept asset prices up, so if stimulus is due to be reduced, stocks should follow it lower.

US indexes were essentially flat on Friday on light pre-holiday weekend volume.

See Part 2 for lessons and conclusions