Interest rates have resumed their ascent following a brief summer pause. And, in recent weeks, their climb has accelerated.
Aside from lower bond prices, what do higher rates mean for other assets, such as stocks and commodities?
It might seem like a simple question. But its relevance is undeniable given the current market conditions.
We’ve been vocal about the cyclical areas of the market that benefit most from a rising rate environment – think commodities, energy, materials, and banks. We’ve put out plenty of trade ideas in those areas.
One simple concept has served me well over the years: Don’t fight the primary trend.
There are many other best practices I use to maintain my sanity regardless of underlying market conditions. But sticking with the underlying trend is fundamental to any trader’s success.
As Charles Dow established more than a hundred years ago, trends persist! This concept is one of the key Dow Theory tenets and forms the foundation of any trend-following strategy.
It’s our job as technicians, traders, and investors to identify the primary trend and ride it as long as possible.
And it’s difficult to imagine a stronger trend in 2022 than the rising dollar.
Gold has been a terrible inflation hedge over the trailing 24 months. It’s gone nowhere since the summer of 2020, while every other commodities have experienced rip-roaring rallies.
The truth is, the "inflation hedge" narrative is just that – a narrative. And I believe it’s false.
But, more importantly, so does price.
I prefer to lean on John Murphy’s observation that gold has a tendency to sniff out inflation, leading to major bull runs in commodities.
And, with gold futures on the verge of breaking down to fresh two-year lows, I think it’s a good time to revisit this often misunderstood metal.
Remember, gold was the first commodity to rally in 2019 – a full year ahead of the rest of the rest of the space.
Here’s a chart of gold futures overlaid with our equal-weight commodity index, highlighting the base breakouts:
After Federal Reserve Chair Jerome Powell’s remarks this morning, the market is pricing in an 86% chance of a 75-basis-point hike later this month.
Meanwhile, rates continue to accelerate at the short end of the curve. That’s been the story for months now.
But will the middle and long end of the curve head higher as well?
According to the two-year US Treasury yield, the answer is a resounding "yes!"
Short-duration rates offer plenty of valuable, leading information regarding US Treasury yields.
We’ve leaned on the five-year yield throughout the current cycle as an early indication of the direction of the 10- and 30-year. It’s proved a beneficial practice.
Today, we’re going to drop it down a notch, extending the same logic to the two-year yield.
Here’s a quad-pane chart of the two-, five-, 10-, and 30-year US Treasury yields:
Heading into Q3, we wanted to play a mean-reversion bounce in US treasury bonds. A long list of reasons supported this position:
US Treasuries experienced their worst H1 in history (or close to it).
Bonds were finding support at their previous-cycle lows from 2018.
Commodities and inflation expectations peaked earlier in the spring.
Assets that benefit from rising rates (financials) were making fresh lows.
Global yields were pulling back.
And, quite frankly, our risk was well-defined. We can’t ask for much more. For us, the greater risk was not taking a swing at this trade in the event bonds ripped higher…
Two months later, bonds across the curve are taking out their 2018 lows. The market has proven our mean-reversion thesis wrong. But we can live that because we manage risk responsibly.
It’s the most important part of playing this game.
Easily, the second-most important is to remain flexible.
We look at a lot of charts. And believe it or not, many of them are absolute messes. Sideways, choppy, and trendless describe most markets right now.
It’s just a fact.
But we always find those big bases and tight continuation patterns on the verge of breaking out that keep us turning on our computers every morning. And the market I want to share with you today has both!
Currency markets have provided stellar trading opportunities this year.
It isn't always this way.
Last year was rough. False breakouts and whipsaws were the norm, as most forex pairs and crosses chopped sideways in trendless ranges.
Many of those consolidations have now resolved, as currency markets have begun to trend again. And it’s hard to find a stronger primary trend to bet against than the declining Japanese yen.
We’ve written about the yen multiple times in the past few months, pointing out that The Yen Provides the Base and joking that we could profit by simply buying Anything in Yen.
Today, we’ll follow up by outlining three tactical setups to bet on further yen weakness.
Back in early July, we were looking to buy a bounce in natural gas. Let's just say it was a success, as our target was hit within weeks.
But you have to remember the environment back then. Commodities had experienced a broad sell-off. And natural gas and agricultural contracts such as wheat and cotton had recently experienced drawdowns exceeding 40%.
It might have seemed like a tough call at the time, but for us it was clear. The risk/reward was in our favor as natty pulled back to test a key level. It was that simple.
Fast forward almost two months, and we’re back for more. Our risk is well-defined, and cyclical areas of the market are assuming leadership.
Today, I’ll share how we’re gearing up for a fresh leg higher in natty gas.
First, let’s take a look at the weekly chart of natural gas futures.
Identifying trends is one of the most important jobs of a market technician. Regardless of our time horizon, we have to understand the general direction the market is taking.
It sounds simple, but it’s the foundation of any market thesis.
Once we have the underlying trend nailed down, we can focus on the areas of the market we want to exploit and pinpoint the best tools and strategies to do so.
When I think of the most critical trends to date, my mind immediately goes to interest rates. Rising rates and inflation have been the key drivers for two years now.
Despite some corrective action in recent months, the bond market has been reminding us that we’re still in a rising-rate environment.
Let’s take a look.
First, we have an overlay chart of the US 10-year breakeven inflation rate and the US 10-year yield:
I can’t think of an area of the market we like more than energy.
Both energy stocks and commodities held up better than their peers during the recent bout of selling pressure. And now that they’re starting to reclaim key levels, we want to put our bullish bias to work.
I recently expressed my growing unease with a short crude oil position, given the mounting bullish evidence in energy. So, let's talk about how I plan to flip the book long crude oil futures on a break higher.
The US dollar Index $DXY is trading at fresh highs. Take a look around the currency market. It shows.
Recent attempts to fade dollar strength have failed. The euro has fallen to its lowest level since late 2002. And we’re beginning to see forex pairs experience fresh breakouts in favor of the USD.
It’s certainly not the best look for risk assets. But it’s offering us great trading opportunities, not to mention some very valuable information.
A couple of pairs that are providing both are the USD/CNH and the USD/CNY. Let’s take a look!
