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Index Wrap

I couldn't sleep at all last night

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Have you ever lain awake at night thinking about something that you so desperately want the answer to, that it keeps you from sleeping?

If you read my Index Trader Wrap last night, where I had little input on yesterday's trade, you'll perhaps understand why I didn't sleep at all last night.

A single chart of the 10-year yield? Is that all I could come up with?

Aha! But traders noted that the bulk of reporting that came from some of CNBC's floor reporters like Bob Pisani (at the NYSE), Rick Santelli (Chicago Board of Trade) and Alexis Glick (senior trading correspondent) all mentioned today that among traders (equity, bond, commodity) were all focused on Treasury YIELDS!

Now, before you start thinking "What?! Does Jeff Bailey get all his market information from CNBC, then just regurgitate it to me?" you should know that I do LISTEN to what traders/reporters have to say, build scenarios, test them, to see if they make sense.

But it is at least interesting that floor traders (as reported by CNBC) seemed focused on Treasury YIELDS, that have been RISING.

Key among traders comments today seemed to be RATE OF CHANGE IN YIELDS.

Why would RATE OF CHANGE (which I've discussed in many Index Wraps)

The main concern or question that many market participants are struggling with right now is... Should the Fed have raised interest rates on Tuesday?

Answer #1: The bond market says YES.
Answer #2: The stock market IN NOT SURE.
Answer #3: Gold says NO. (If using Gold below $400 as sign of no inflation, no deflation)

Here's a Market Monitor post that fellow analyst Jonathan Levinson posted this afternoon, from what looks to be another trader's thoughts from yesterday's (Wednesday's action). A very BEARISH equity scenario, but one that offers some EXCELLENT tests going forward.

The reason I'm posting this is because it DIRECTLY addresses market psychology at this point.

Please.... if you are a gold trader, I KNOW that gold above or below $400 isn't necessarily a FINITE LEVEL that can ALWAYS be THE LEVEL for trying to derive some type of benchmark that the Fed might use as a MESSAGE FROM THE MARKET as to its views on what the Fed should be doing (tightening or cutting rates). Certainly the dollar's strength/weakness and perhaps a plethora of other dynamics (which gold traders will always use as a reason to explain its value) can have impact on gold's value.

As general background as to Gold at $400, and Fed policy, I wrote an article in the Ask the Analyst section on August 31, 2003 at this link.

Market Monitor Post - A very BEARISH scenario for stocks

In a moment, I'll outline some TESTS to the above scenario that a fellow trader has laid out. Look at all of the various indicators (housing market, banks, stocks, gold) this trader/investor is smartly following. He or she is not just looking at one equity index to come to a conclusion, but he/she is bringing in different observations, of which we hope to test, to see if the scenario is sound.

Jonathan Levinson outlined what may be deemed an appropriate strategy for profiting from such doom! I've sent Jonathan an e- mail regarding the timing of some of his purchases/sales to see if we can't get a feel for when his realizations triggered action, and perhaps give us important insight as to the MARKET'S thinking of when this scenario came into play.

My gut fell, based on observation, would have to be just about a MONTH ago, when the March nonfarm payroll data was released.

And here's why, but where the ABOVE scenario may have some flaws.

Let's start with Gold, and I'm going to use stockcharts.com's Continuous Gold Contract ($GOLD) and a point and figure chart set on $5-box size, which is more BULLISH looking than the $2-box size chart I've shown in prior Market Monitor posts, where Dorsey/Wright and Associate's, which many institutions will use, views the various gold futures contracts at.

Continuous Gold Contract ($GOLD) - $5 box

Did Fed keep rates unchanged because gold was under $400 on Tuesday May 4, 2004? Fed might have. Remember the criticism the Fed has taken because it was too aggressive with the raising of rates back in 2000, when gold was well below $300. Historians will remember that in late 2000, there was GREAT concern about wage inflation as unemployment was VERY LOW, and kids coming out of college with any type of computer/engineering degree were able to demand BIG salaries as employers couldn't find enough bodies to meet demand for products. The Fed may be hesitant to raise rates as it weighs current economic signals (including jobs) against raising rates.

On a more recent note/observation, what has gold done since the last nonfarm payroll report showed the economy generated 308,000 jobs (this can be revised tomorrow, but was well above consensus estimates of 123,000)? Gold has fallen, at least by my observation.

Will gold skyrocket? Not sure, but it is below $400, and Spot Gold in New York fell $5.20, or 1.32% today to close at $387.75. Tomorrow's nonfarm number could be important to gold. It seemed to be important a month ago.

Now, here is where the BEARISH scenario described in the market monitor is further tested, and where the trader/investor saying that "it does not matter what Greenspan says, the traders are taking over, as raw material prices are soaring and eventually the markets will control interest rates, not the Fed," has some credibility.

10-year YIELD ($TNX.X) Chart - 0.50 box size

I agree with the trader in the market monitor that says traders are taking over..... eventually markets will control interest rates." Since the March nonfarm payroll was released, on April 2, the 10-year YIELD has risen rather SHARPLY.

And this is where I think "gold bugs" need to be careful for what they seem to be wishing for.

When making a recent time comparison between the 10-year YIELD and gold prices, the bond market has seen selling, with YIELD rising, which creates higher borrowing costs for you and I.

This may well begin to dampen the fast pace of economic growth, which has some market participants believing INFLATION will begin to run rampant!

Gold should become a very important indicator to these thoughts in the weeks to come. Right now, with gold showing some weakness back below $400.00, other market participants, and perhaps the Fed, aren't so certain that inflation will be a concern.

Now, how confident are bond traders in their recent trading and reading of the Fed? Here's a 30-minute interval chart I posted in the Market Monitor today.

My main point is the observation of recent trade when the FOMC announced its decision on interest rates (keep them unchanged at 1%), where again, it would see that bond traders were uncertain, bought bonds as a knee-jerk reaction, but YIELD has moved up since late Tuesday afternoon.

10-year YIELD Chart - 30-minute intervals

Today I "discovered" that QCharts had recently added a DAILY and WEEKLY pivot analysis tool, which displays the various WEEKLY Pivot levels on a chart.

Now.... Rick Santelli, who was a bond trader and follows the interest rate complexes in Chicago made comment today that there is great disagreement among some bond traders as to how bonds have been trading, in relation to the FOMC's recent wording released with Tuesday's FOMC statement.

He said that many traders feel that tomorrow's nonfarm payroll numbers better come in almost "exact" as the bond market might be priced to perfection right now, and that if bond shorts are wrong, there's a window about the size of this (he made a small circle with his hands) where shorts will be able to escape.

I'm paraphrasing his comments, but what he is saying (or I think he is saying) is that the bond market is NOT necessarily following the Fed's thoughts as to "a measured approach to interest rates," which many interpret to mean that the Fed isn't in a hurry to raise rates at this point.

Why is this? I think it is because the Fed feels it should still see if job growth is showing a sustainable recovery. Correct me if I'm wrong, but I think the Fed has mentioned before that it wants to try and make sure, as long as it sees inflation not a threat, that the jobs market shows signs of sustainable recovery.

Still, the BOND market seems to be struggling with Fed policy right now, and I would have to say that the SHARP rise since the last nonfarm report is where some type of "realization" set in.

Uncertainty from the bond market may also have been shown on Tuesday, when some bond traders immediately BOUGHT the 10-year YIELD when the Fed left rates unchanged, but suddenly, a round of selling took YIELD back higher, most likely from bond BEARS that thought the Fed might be falling behind and should have tightened, based on the prior nonfarm payroll numbers.

Again, tomorrow's nonfarm numbers will probably be KEY to the bond market. If jobs data is "hot" and much stronger than expected, we should be prepared for bond traders that believe the Fed is falling behind, and will eventually have to be much more aggressive with its tightening.

If the nonfarm numbers come in to the SATISFACTION of the market, then we could see buying come into Treasuries, where traders suddenly say, "hey, the Fed might be right."

Still, today's equity market action certainly suggests that the closer the 10-year YIELD gets to 4.668%, the jittery stock traders are getting.

Market Snapshot / Internals - 05/06/04 Close

Two notes. The QQQ closed a penny above Tuesday's close (after FOMC meeting). Still a choppy trade, and equity traders seem somewhat uncertain about things. However, the other major indices are below Tuesday's close. Bearish is that the number of new lows at the NYSE grow to levels not seen in more than a year, suggesting there is definitely bearish leadership, or lack of bullish leadership, and most likely has to do with Fed policy, if not the rather SHARP rise in YIELDS of late.

S&P 500 Index Chart - Daily Intervals

The SPX was "prime" for a decline below the 1,107.23, if not the overlapping support of 1,111. However, a late spat of buying to the close (uncertainty about the nonfarm) may have had some bears looking to cover into the nonfarm report.

NASDAQ-100 Tracker (QQQ) Chart - Daily Intervals

Volume levels from today's QQQ trade doesn't look like there were many "big bets" made into tomorrow morning's nonfarm payroll numbers, and the recently added short-term trend survived its first test.

Going into tomorrow's trade I've got to think that a negative reaction would find Treasury YIELD shooting higher, QQQ breaking below today's trend, and vulnerable to MONTHLY/WEEKLY S1.

If nonfarm payroll comes in "exact" to what the MARKET thinks it needs to be (not economists' forecast necessarily), then YIELD calm to lower, and QQQ could see a relief bounce move back higher toward WEEKLY R1, where test for strength is above the MONTHLY Pivot.

Dow Industrials Chart - Daily Intervals

The INDU was the only major index to close back below an overlapping level of near-term support at the 10,255 level.

What this could mean, or tell us, is that this slower moving (in daily percentage terms) didn't find the squaring up of trade into an important economic release. In other words, if market reaction is NEGATIVE or POSITIVE, then INDU and perhaps DIA/DJX isn't going to cause the trader that held overnight as much harm (percentage loss). If there is anything I would read into this, is that institutional computers weren't willing to buy into the economic data, or provide support at the 10,255 level, and may be a hint for a sell bias into tomorrow's trade.

As such, traders will be very careful, and not be overly aggressive with any new position adds in tomorrow morning's early trade.

I have had some computer memory problems tonight, and have had some type of trouble loading up my Excel spreadsheet to update the pivot analysis matrix. I will work on this "problem" tonight, and post the matrix in the Market Monitor tonight, or in tomorrow morning's 09:00 AM EDT update.

Jeff Bailey

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