had a few bumps along the way but has been fairly steady. The latest breakout has come in the wake of the lower than expected US inflation data. Markets are increasingly pricing for a less hawkish Fed and this is supportive for equities. However, to be sustainable, a peak in yields is probably needed, whilst the new positive outlook on equities needs to hold support.
- US bond yields turning lower have helped equities, whilst “real” US bond yields are no longer rising.
- Reaction to the key breakout supports on indices will be a crucial test of the new positive trends.
Equities on the rally
Equity markets turned a corner in early October. On major markets, the Dow futures and German DAX index bottomed on 3rd October, whilst it was just over a week later when other majors such as the S&P 500 futures and FTSE 100 index put in a key low.
Since then there has been a firm recovery. The performance of some markets, especially the NASDAQ 100 futures, has been rather erratic in recovery. However, most markets have been tracking solidly higher.
A top in US yields is helping
Last week there was an undoubted boost to sentiment on the back of the US CPI falling more than expected. This came as a shock to markets that had been consistently served with higher-than-expected US inflation numbers that then had pushed expectations of Fed rate hikes even higher.
However, the US CPI downside surprise caused yields to drop around 50 basis points (on both 2s and 10s) as markets priced for an earlier end to Fed hikes, and more importantly a lower terminal rate. Fed Funds futures now price for a terminal rate of around 4.9% (it had previously been around 5.10%). This is positive for equities and has boosted the rally further.
But as we said earlier, the rally on equities has been moving higher for several weeks. This has come as “real” US bond yields (US bond yields minus inflation) have stopped rising. There is a strong negative correlation (averages around -0.35 over the past 12 months) between real yields and how S&P 500 futures have performed in 2022. Real yields have been moving sharply higher, hitting the outlook for Wall Street.
However, in recent weeks, real yields have become stuck. They have moved sideways, allowing a more stable outlook to develop on equities. Note the strong negative correlation currently in place. If real yields continue to slip lower, this will be supportive for equities.
The recoveries have been impressive, but the moves need to continue. Some markets have lagged (NASDAQ and subsequently the S&P 500) but some have been extremely strong (DAX and the Dow). However, from a technical basis, with new uptrends forming, markets need to build on the breakouts to make old resistance become new support. This is a cornerstone of a decisive recovery.
The Dow futures (DJ30ft) have been leading the Wall Street recovery. The uptrend is decisive and momentum is strong. However, the move is now coming up to huge resistance of the August high around 34250. The recent breakout above 33100 now means that there is a key band of higher low support at 32500/33100. This band of around 600 ticks of support needs to hold on a pullback to sustain the breakout. If the resistance at 34250 can be broken it would be hugely positive.
From a technical perspective, the German DAX (GER40) is even better positioned. It has already broken out above its key August lower high of 13970. However, the bull run has taken the RSI above 70 and it is beginning to look stretched. This could induce a near-term technical unwind. We see the support band between 13665/13970 as a key area of breakout support.
The tech-laden NASDAQ has massively lagged the recovery of the Dow. However, that may mean that if real yields do begin to fall back (NASDAQ performs best when yields are falling), it could be a significant boost to recovery on NASDAQ 100 futures (NAS100ft). It has completed a base pattern in the past few days (helped by US CPI) and this move above 11730 implies a recovery target of 12825.
There is plenty of upside potential in momentum with the RSI confirming the base but only in the high 50s. Once more, if bond yields fall this could mean very quickly the performance improves. The bulls will therefore need to work hard to hold on to support to sustain the recovery momentum. The breakout band between 11620/11775 ideally needs to hold now.
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