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Economic Warning - Flashing Yellow?

Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen arrive in Congress for two days of testimony. It comes after the U.S. Producer prices posted the biggest annual gain in more than 10.5 years. Wholesale prices increased 1% from May and jumped 7.3% in June from a year ago for a record surge. Higher used auto prices, higher airline fares, and other items also pushed Consumer Price Index up as the Labor Department reported last month's CPI increased 5.4% from a year before.


As the recovery from the pandemic gained steam, economic numbers moved sharply higher from the low numbers from last year, when the Covid-19 lockdowns led to prices plummeting.

During the testimony at Congress today, the Fed chief responded to concerns from various lawmakers about the recent high inflation readings. FED Chairman Powell once again reiterated that inflation is transitory. Powell reaffirms to lawmakers that if inflation expectations move up well above their guidelines, the FED will use the tools in their arsenal to guide inflation back to 2%. The FED would stand ready to cease its emergency asset purchases and begin to raise interest rates to ease inflationary pressures if needed. Powell stressed the FED must not overreact. It will be a mistake to act prematurely because inflationary pressures will be temporary.


Technically speaking, we have been closely monitoring key commodity prices such as the CRB Index (CRB – 213.38), WTI Crude Oil (WTIC – 73.13), Copper futures (4.27), Lumber futures (612), and others. Although CRB Index and WTI Crude have performed well in recent weeks, Copper, Lumber prices, and other commodities have declined sharply from their May 2021 highs. The discrepancies in commodity prices support the FED's chair stance that the pent-up demand and the low supply from the pandemic may be temporary as prices return to normal.

Many view the bond market as a leading predictor of economic conditions. Bond market performances reflect investor's expectations of future economic conditions for six to twelve months. Although the bond market is not always correct, it has a strong track record as a leading indicator of economic trends. For this reason, smart money and professional investors turn to the bond market to gauge the consensus expectation of the economy.


The bond market may be nearing a critical phase, as evidenced by the iShares 20+ Year Treasury Bond ETF (TLT – 146.87) testing its 200-day ma (147.08). The transition from a bear market trend to a bull market trend requires the price to cross above its 200-day ma and maintain its 200-day ma. The crossover hints at the potential for a trend reversal, but the ability to stay above the moving average on pullbacks confirms a trend reversal.


The enclosed chart shows TLT has improved from its Mar/May 2021 lows (132.45/134.99). Although there is the potential for a bottom, the recent overbought readings (RSI = 61.68) only generated a modest decline in the overbought/oversold indicator, signaling the potential for a primary trend reversal or the start of another technical basing pattern.


However, recent market actions of TLT to follow through with its breakout above the 200-day ma (147.08) and failure to clear convincingly above the Jan 2021 breakdown (150.80) and the 38.2% retracement (149.19) from Mar 2020-Mar 2021 indicates that the breakout may have been a whipsaw. Remember, bear market rallies are explosive but tend to be deceptive with false breaks above the 200-day ma. The failure of the price to maintain above its 200-day ma breakout can also signal a peak (right shoulder) and warns of a test of neckline support (131-132.45). A breakdown below the neckline would confirm a head and shoulders top pattern or a descending triangle formation.


In conclusion, the bond market is an important leading indicator of future economic conditions. TLT may be approaching a pivotal phase of its recent recovery. Failure to convincingly clear above its 200-day ma (147.08), 38.2% % retracement (149.19), and Jan 2021 technical breakdown (150.80) may lead to a retest of its Nov 2019/Mar 2021 lows (131-132.45) or neckline support to a head/shoulders top or descending triangle pattern. The outcome of these technical tests may confirm or non-confirm future inflationary pressures. After all, bond investors, as a group, are generally conservative and less prone to speculative behavior as compared to stocks or commodities traders. If nothing else, the bond market can be a proxy for future economic conditions, even if this expectation is sometimes incorrect.


Source: Courtesy of StockCharts.com

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