Stocks fell and the US dollar strengthened on Monday.
One of the reasons that could have triggered the move was a stronger-than-expected ISM services read in the US, which came in above expectations, and hinted that the economic activity, at least in the US services sector continues growing, and growing un-ideally faster-than-expected despite the Federal Reserve’s (Fed) efforts to cool it down.
So, the economic data may have fueled the Fed hawks yesterday, although I just want to note that another data, which is PMI services remained comfortably in the contraction zone at around 46.
But the fact that the S&P500 was flirting with critical yearly resistance may have played a bigger role in yesterday’s selloff.
The S&P500 shortly traded above the year-to-date bearish channel top last week without a solid reason to do so. The pricing in the markets barely reflects the scenario that the US rates will go above the 5% mark. Therefore, a downside correction was necessary to reflect the reality of the Fed game.
Some people say that it’s because the market sees the Fed’s bluff. But at the end of the day, if Fed’s bluff of tighter policy doesn’t do the job, then the Fed will have to do the job itself.
In the short run, the S&P500 may have seen a top near 4100 and could opt for a further downside correction, with the first bearish target set at 3956, the minor 23.6% Fibonacci retracement on the latest rally, then to around 3870, the major 38.2% retracement level and which should distinguish between a short-term bearish reversal, and the continuation of the latest bear market rally.
Looking at the FX, the Aussie was slightly better bid after the Reserve Bank of Australia (RBA) raised its rates by another 25bp today, and took the rates to levels last seen a decade ago.
Elsewhere, the US dollar strengthened as a result of the hawkish Fed rectification. The dollar index first eased to a fresh low since June, then rebounded. It has way to recover above its 200-DMA, which hints that some majors, including EURUSD and Cable could return below their 200-DMA as well.
Yet, even if we see rebounds in the US dollar, the medium to long term direction of the dollar will likely be the south in the coming months.
The currency markets are not like the equity markets, or the cryptocurrency markets. The valuation of one currency cannot go to the moon, forever. Therefore, it is possible we will see the EURUSD recover to 1.10 and Cable to 1.30 within the next 3 to 6 months.
Even the Japanese yen, which has been the black sheep of the year, is expected to do much better in the coming months.
Analysts at Barclays and Nomura expect the yen to rally more than 7% next year – which is not a big deal if you think that the US dollar gained up to 30% against the yen since the beginning of this year.
Vontobel sees the yen’s fair value below the 100 level against the US dollar, which, on the other hand, is a bit stretched as the dollar-yen hasn’t seen that level since 2016, and it was a short visit. The last time the dollar-yen was really below 100 is before 2013.
What’s more realistic is, we see the dollar-yen trend slowly lower. In the short-run, resistance at 140 should keep the pair within the bearish trend with the next downside target set at 130.