From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley    

When it comes to the bond market, credit spreads are always top of mind. They provide critical information regarding the liquidity and stress of the largest markets in the world.

While most of us aren’t full-time bond traders, in many cases we turn to these assets to offset the risk associated with the equity side of our portfolios. That’s fine.

But when credit markets come under stress, it affects all asset classes, especially equities. We’re seeing this now.

Earlier in the month, we noted that these crucial spreads were widening to their highest level since late 2020 as the high-yield bond versus Treasury ratio $HYG/$IEI hit new 52-week lows. 

It’s no coincidence that the major stock market averages fell to their lowest level in over a year as this was happening.

This is why we pay close attention to credit spreads. They give us information about the health of other risk assets.

From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley

The US dollar is front and center as risk assets hang in the balance.

Earlier in the month, we placed the Australian and Canadian dollars on breakdown alert as they completed major topping patterns.

US dollar strength was expanding at the time, and the AUD and CAD were the last dominos to fall.

Or so it seemed.

What started as strong downside resolutions for these top commodity currencies quickly turned into potential failed breakdowns.

Now that the most resilient currencies are snapping back against King Dollar, it's compromising the broad US dollar rally and could usher in a more favorable environment for risk assets. 

Let’s discuss what it means for stocks and commodities if these failed breakdowns resolve higher.

Here’s a chart highlighting the recent action in the Canadian dollar and Australian dollar futures:

From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley

Markets trend. Trends persist. 

Those crucial Dow Theory tenets form the foundational premises of technical analysis.

As technicians, identifying trends is a central component of our work.

But, most of the time, markets remain range-bound, as we experienced during the choppy mess that dominated the stock market and so many risk assets last year.

However, during that time, commodities continued to rip higher.

Now that the rally in raw materials is reaching significant areas of overhead supply, it would make sense for this leadership space to follow stocks and enter a corrective period.

In other words, the uptrend in commodities that has persisted since 2020 is likely to take a breather and turn into a sideways trend.

Let's talk about it.

From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley

Bonds are digging in at some familiar levels.

For years now, we’ve pounded the table about the importance of the 2018 highs for various risk assets.

That’s because those former highs marked significant peaks for both the stock market and certain procyclical commodities and currencies during the last cycle.

As far as the bond market is concerned, 2018 was also when yields peaked. Benchmark rates in the US are testing these old highs.

As such, it’s not the 2018 highs but the 2018 lows that we’re paying attention to when analyzing the prices of Treasuries.

A handful of bonds and bond funds are trying to find a bottom at these key former lows right now. 

Let’s take a look.

Here’s a chart of the 20+yr T-Bond ETF $TLT:

From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley

Copper is challenging the lower bounds of its range.

The AUD/JPY is attempting to reclaim former support.

And the S&P 500 is digging in at the AVWAP from its COVID lows.

These are some of the most important charts and levels in the market right now. 

But there’s one chart that tops them all… 

In our view, the US Dollar Index $DXY is the key to this market. 

It’s currently struggling to resolve higher from a multi-year base after reaching its highest level since 2002.

The breakout could stick and lead to a sustained uptrend. Or, it might fail. Either way, the outcome will have wide-ranging impacts on risk assets.

If the breakout from this multi-year double bottom is a valid one and the dollar continues to trend higher, we’ll continue to see downside pressure for the majority of risk assets.

From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley

There’s always a bull market somewhere.

But the environment is tough right now.

Volatility is sweeping across markets. The dollar is catching a defensive bid. And the major averages continue their downward trajectory as investors desperately look for signs of a bottom. 

Yet, despite the bearish action gripping markets, we’re still finding bases we want to buy.

And, to no surprise, many of those smiley faces are in the commodities market.

That’s where we want to focus our attention.

Today, we'll highlight the wheat complex, outlining some tactical setups that complement our bullish structural outlook for commodities and grains.

Let’s dive in!

First up, we have Chicago wheat:

From the desk of Steven Strazza @Sstrazza and Grant Hawkridge @granthawkridge

Defense wins championships. 

It’s important to remind ourselves of this as risk continues to come off the table.

The largest stocks in the world are losing critical support levels, and even the leaders are coming under pressure. Bonds are catching a defensive bid, credit spreads are as wide as they’ve been in years, and investors are fleeing to the dollar for safety.

Meanwhile, the classic risk barometer – the AUD/JPY – is breaking to fresh lows.

This all speaks of defensive positioning.

Here’s a daily chart of the AUD/JPY:

From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley

Credit spreads are widening to their highest levels since late 2020.

If it feels like we just mentioned spreads and the falling HYG/IEI ratio, it’s because we did – and for good reason! They provide valuable insight into the overall health of the market.

High yield bonds $HYG rolling over faster than US Treasuries $IEI implies stress on credit markets and trouble for equities.

This is critical information.

We’ve been closely following the HYG/IEI ratio for months as it repeatedly tests the lower bounds of its range. It broke down to fresh lows in March, only to bounce higher with many risk assets.

Two months later, this crucial risk ratio is printing fresh 52-week lows again. The main difference is that the overall market environment has drastically changed since the last time we were at these levels.

From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley

Despite the rising US Dollar Index, strength among commodity-centric currencies has been a key theme for much of this year. 

Today, that’s no longer the case.

The rally in the USD is accelerating, as dollar strength broadens to even the most resilient currencies. 

Two of the top commodity currencies – the Australian and Canadian dollars – are undercutting the lower bounds of their current ranges and making fresh 52-week lows.

These breakdowns mean the path of least resistance is now lower. If these are valid resolutions, we’re looking at increased headwinds for risk assets.

Let’s look at a couple charts of the AUD and the CAD, highlight the levels we’re watching, and discuss what continued weakness in these major currencies means for stocks and commodities.

First up is the Australian dollar-US dollar cross:

From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley

A few weeks ago, we pointed out widening crack spreads and what they meant for oil refining stocks. You can read more here, as we explain how wider crack spreads support higher prices for this particular area of the market.

Three weeks later, crack spreads have widened to their highest level in more than a decade.

This post is not about crack spreads, though. It’s about energy and how everything in the space is working these days. 

Bullish rotation continues to be the theme for energy.

This week, gasoline was the standout, booking a 10% gain and breaking out of a massive base to new all-time highs.

Let’s take a look at the breakout in gasoline futures and discuss what it means for crude oil.

From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley

While most uptrends have come under pressure in 2022, the US dollar has remained as strong as any.

This dollar strength, particularly at the index level, is nothing new. We've been discussing it.

It's been taking place all year, driven by the major pairs such as the euro, the yen, and the pound.

However, something new is the burgeoning strength beneath the surface, even outside of the big developed market currencies. We've been seeing dollar internals improve drastically in recent weeks.

And now we're seeing momentum accelerate for the US Dollar Index $DXY. Today, DXY is on track for its largest single-day gain since the pandemic crash more than two years ago.

All of the evidence suggests this dollar strength is the real deal.

Let's talk about what it means and how we want to position for it.

Here's the US Dollar Index ripping to its highest level in almost 20 years:

From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley  

The rally in some commodities has been near-vertical this year.

And we’re seeing this strength across the entire complex -- from energy contracts like crude oil to base metals such as tin and even grain markets like wheat.

While these kinds of moves are bullish over longer time frames, when things get too hot (like they have), it’s often not sustainable on a tactical basis. 

This is the situation right now for a lot of commodities. We think a period of well-deserved digestion is underway for the broader asset class.

But this doesn’t mean there won’t be fresh up-legs taking place in some individual contracts.

As this new secular bull market matures, pockets of strength will rotate across the space. Our only job is to find the emerging leadership.

Today, energy and base metals are correcting after explosive rallies while strength emerges from the agricultural complex -- especially grains.