STARS ALIGNING - So the month of May is kicking into gear with the first full week underway, and it will be interesting to see if Friday's wild whipsaw price action opens the door for some much desired volatility. It is way too early to call for anything at this point, but I was pleased to see the in the final hours of Friday trade, the US equity market settled with an offered tone.
We had initially seen a surge in risk assets, with stocks, USD/JPY and EUR/CHF bid post the NFP release. But all of these markets ended the day with some good downside pressure. I would have been able to reconcile the price action had these markets closed higher, but in my view, the bearish direction has been much easier to digest and a welcome development. And why is this? Well, with the unemployment rate dropping well below the 6.5% Fed threshold, this now takes us even closer to a Fed policy reversal.
Higher rates means less incentive to buy risky assets, and as such, should weigh on these markets. It isn't about when the Fed hikes, but what is priced into the market. Before Friday's report, the market had been pricing a rate hike in further down the road, and after the report that timeline moved up. So we now have interest rate differentials narrowing back in favor of the US Dollar and disincentivizing risk investment.
RUNNING OUT OF WIGGLE ROOM - I would also add that despite the blowout headline numbers, the marked drop in the participation rate was not a positive for the economy (contributed to lower unemployment). And as much as the market wants to continue to rally on bad news, you get to a point where the Fed is fully extended and backed into a corner, and there is no longer any real justification to buy on the bad. I think we are very close to that point. So what now? Well now, you will be hearing a lot more Fed talk on inflation being contained and this being the reason the central bank will still need to keep policy ultra accommodative. Yet, the Fed is running out of wiggle room, and with the most recent inflation print jumping up to 1.5% and coming in hotter than expected, we could be awful close to that 2% target. As highlighted on Friday, the June monetary policy decision is going to be a big one, and it looks like the stage is being set for some major fireworks. The question now is how much the market wants to consider this reality? Keep an eye on US equities, USD/JPY and EUR/CHF. These are my big three and the direction in these markets will be critical in being able to gauge broader market direction. All three of these markets point to weakness ahead, and all three could really accelerate to the downside if some key levels are broker. I would say SPX 1800, USD/JPY 100.75 and EUR/CHF 1.2100 are those major levels you want to pay attention to this week. Let's see how it plays out.