Bitcoin - Buckle Up for the Downward Spiral RideCME: Micro BTC Futures ( CME:MBT1! ) and BTC Options ( CME:BTC1! )
On December 11th, Bitcoin is trading at $16,890, down 63% year-to-date. Current price falls below 50-day moving average (MA) of $18,300 and 200-day MA of $26,470.
Meanwhile, Open Interest of CME Bitcoin Futures (BTC) has been growing from about 8,000 lots to 14,000 in December. This strongly suggests that Bitcoin investors are bearish and increasingly use futures to hedge their investments.
Is Bitcoin a commodity, a security or a currency?
This is a $1 trillion question. Regardless of your own view, what really matters is how financial regulator in your country of residence defines it.
In the US, there is a turf war among federal regulators for oversight of the crypto market. A recent Senate bill, if becomes law, would task Commodity Futures Trading Commission (CFTC) as the primary regulator for Bitcoin and Ether.
Indeed, Bitcoin shares key characteristics with other commodities. It’s homogeneous (all Bitcoins are of the same quality), fungible (can be divided up to trade), and with finite supply (21 million in all). Just like gold, it takes labor and cost to mine new Bitcoins and they can be stored for future use.
We can’t say the same for other cryptocurrencies. Those issued through an initial coin offering (ICO) resemble stock IPO, and could fall under the jurisdiction of SEC. As a stock investor, you understand that any company could go bankrupt, rendering its stocks worthless. So is the risk of any ICO.
Bitcoin is a virtual currency, even the CFTC says so on its website. It facilitates transactions across borders and can be stored as a means for wealth. However, price volatility of Bitcoins is too large to make it a functional currency, limiting its appeal to the general public.
Risks Associated with Bitcoin Investment
Let’s say we agree that Bitcoin is a commodity. We need to understand its unique risks compared with other types of financial assets.
Firstly, extremely high volatility. Below is annualized volatility of various markets. While Bitcoin promoters point to its decentralized structure as a safe investment, it is nevertheless a very risky asset as measured by the off-the-chart price volatility.
• Bitcoin: 80.6% (as of December 4th)
• S&P 500: 24.01% (as of December 9th)
• Gold: 16.45% (as of December 8th)
• Euro/USD: 24.71% (as of December 9th)
• WTI Crude Oil: 46.82% (as of December 7th)
• 10-Year Treasury Note: 6.41% (as of December 11th)
Secondly, extremely vulnerable to event risks. Bitcoin is built upon global consensus. An unexpected major event could result in a market rally if it strengthens such consensus. On the other hand, Bitcoin price could be crashed, if the consensus is weakened.
• El Salvador announces to make Bitcoin a legal tender (market rally)
• Elon Musk tweets that Tesla no longer accepts Bitcoin as payment (market crash)
• China bans cryptocurrency trading and mining (market crash)
Thirdly, regulatory risks. If you trade on an unregulated Exchange, your crypto assets do not enjoy the same legal protection as a trading account at New York Stock Exchange or Chicago Mercantile Exchange would have. The demise of No. 2 Crypto Exchange FTX serves as an example of such risks.
Finally, crypto assets are vulnerable to hacking whether you store them with an Exchange or in a digital wallet. You also run the risk of not being able to retrieve your bitcoins if you forget the private keys or misplace your password.
Bitcoin Trading Using Futures Contracts
Every trade has a Long and a Short. If you have a short-term trading horizon, you should be prepared to take either side depending on whether you are bullish or bearish.
BTC futures are good instruments to express your view with limited amount of money. CME Micro BTC (MBT) is based on 1/10 of 1 BTC. Initial margin is $430 per contract, about ¼ of the full cash value.
For anyone who is a HODLer and invests in Bitcoin for the long haul, its 63% decline in a year is very hard to swallow. Hedging your position is a good way to minimize large drawdown on your portfolio. Put options on BTC futures is a vehicle to achieve just that.
In my trade idea published in June, I called out an "Unstoppable Downtrend" in Bitcoin and recommended buying CME BTC Put Options. On June 2nd, Bitcoin was $30K. On June 14th, it dropped 25% to $22K. If you bought a put option of BTCM2, you could have realized a sizable return. (Please read the original trade idea for details.)
Where will BTC go from here?
Technical indicators suggest potential breakout to the downside, as we discussed earlier.
Fundamentally, I think that Fed rate hike is the dominant price driver across global financial markets these days, stocks, bonds, FX, commodities and crypto included.
BTC price is inversely related to treasury yield. If the Fed sticks to a 75-bp hike, 10-Year Yield would rise and BTC could fall. However, if the Fed moderates to a 50-bp increase, the opposite could happen. Therefore, I would watch the FOMC decision on December 14th closely. This would guide us for longer-term market direction in 2023.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs www.tradingview.com
Ratehike
As we approach the last Fed/ECB meetings of the year.Last week, while the Federal Reserve changed its rhetoric from ‘hiking to fight inflation at all cost’ to ‘slow the pace of rate hike’, seismic waves rolled over the markets.
As we approach the last central bank meetings of the year, the ECB meets on (15th Dec), Fed on the (14th Dec). A temperature check on the expected path of rates for the 2 major central banks would give us a good sense to position ourselves.
The Fed
After Fed Chair Jerome Powell’s speech last Wednesday at the Brookings Institution in Washington, one line in particular (“The time for moderating the pace of rate increases may come as soon as the December meeting.”) shifted the market’s perspective. With the USD weakening further and terminal rates repricing slower and lower than expected, markets seem to have priced in a 50-basis point hike by the Fed in its December meeting. A slowdown from the back-to-back 75 basis point hikes we have come accustomed to.
As noted in the chart above the EURUSD pair has generally moved alongside the dollar direction, should the dollar continue its tumble downwards, the EURUSD is likely to trade higher.
The ECB
After raising rates by 75 basis points in the last meeting to 1.5%, the ECB still faces mounting inflation. Market expectations still swing between a 50 to 75 bps hike for the upcoming ECB meeting as the Eurozone still struggles with high inflation. The ECB may also have more headroom to maneuver as current rates remain below the expected terminal rate and the 200 basis points hike still pales in comparison to the Fed’s 375 basis points move.
However, we do have to caveat that intricacies matter here, for example, the inflationary effects in the US are largely driven by the demand side, while in the Eurozone are driven by supply-side effects. Regardless, the next few days will remain key for any policymaker comments to guide the markets as the meeting date nears.
Policy timing and direction uncertainty put the EURUSD pair on our watchlist. The last time the 2 central banking policy timelines diverged, we called it out on one of our previous ideas. You can check out here .
Additionally, we spot an ascending triangle pattern on the chart which generally signifies a bullish continuation. With the previous ascending triangle breaking out in a textbook manner, we will watch if the current setup trades the same. Prices have also broken a previous support-turn-resistance level, which could prove as further conviction of the upward move.
With a clear technical setup and the potential for the ECB to surprise hikes to the upside, we lean bullish on the EURUSD pair. We set our stop at the 1.0440 level, and take profit level at 1.0900, with each 0.00005 increment per EUR in the EURUSD futures contract equal to 6.25$.
The charts above were generated using CME’s Real-Time data available on TradingView. Inspirante Trading Solutions is subscribed to both TradingView Premium and CME Real-time Market Data which allows us to identify trading set-ups in real-time and express our market opinions. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
Disclaimer:
The contents in this Idea are intended for information purpose only and do not constitute investment recommendation or advice. Nor are they used to promote any specific products or services. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. A full version of the disclaimer is available in our profile description.
Sources:
www.cmegroup.com
www.ecb.europa.eu
www.federalreserve.gov
Interest Rate Futures and the First Cash Settled ContractCME: Eurodollar Futures ( CME:GE1! ), CBOT: Treasury Bond Futures ( CBOT:ZB1! )
This is the second installment of the Holidays series “Celebrating 50 Years of Financial Futures.”
Before 1970, commercial banks did business by accepting short-term deposits at low regulated rates and offering longer-term business and personal loans at higher rates.
Double-digit inflation changed all that. Federal Reserve eliminated interest rate ceilings on time deposits under 3 months in 1970, and on those over 3 months in 1973. Banks incurred huge loss from a negative spread with deposit rate higher than loan rate.
Fast forward to 2022, we find ourselves in a high inflation and an inverted yield-curve environment again. The overnight Fed Funds rate (4.00%) is nearly 500 basis points higher than the 10-Year Treasury Note (T-Note) yield (3.51%) as of December 4th.
Rising interest rates increase the financing cost from businesses to households alike. The Fed’s six consecutive rate hikes from March to November 2022 contributed to significant drawdown in the value of stocks, bonds, and commodities.
If you bought $100,000 of Treasury bonds (T-bonds) in January, its market value could drop as much as 30% with bond yield jumping to 3.5% from 1.5%. If you owe $10,000 in credit card debt, monthly interest rate charge could run up to 25% a year from 15%.
Like foreign exchange, interest rate is not a physical commodity. It is a right to holders of an interest-bearing product, and a liability to its issuer. The above examples show that both buyer and seller could have large financial exposure to changes in interest rates.
To hedge interest rate risks, futures contracts were invented in Chicago futures markets, namely, Chicago Board of Trade (CBOT) and Chicago Mercantile Exchange (CME).
CBOT Ginnie Mae Futures
Government National Mortgage Association is a US government supported entity within the Department of Housing and Urban Development (HUD). The nickname “Ginnie Mae” come from its acronym GNMA.
GNMA issues Ginnie Mae certificates, a type of mortgage-backed passthrough securities. Investors receive interest and principal payments from a large pool of mortgage loans. Since timely payments are backed by the full faith and credit of the US government, Ginnie Mae bonds are considered default risk free and have an AAA credit rating.
Although they are free from default risk, holders of Ginnie Mae bonds are exposed to interest rate risk, as bond price moves inversely with bond yield. Sensing the need from savings and loans, mortgage bankers, and dealers of mortgage-backed securities, CBOT launched Ginnie Mae Bond Futures in October 1975.
This was the first time a futures contract was based on an interest-bearing instrument. At contract expiration, futures buyers would receive actual Ginnie Mae bonds from futures sellers. While the Ginnie Mae contract has since delisted, it paved the way for the successful launches of other interest rate futures contracts in the 1970s and 1980s.
CME Treasury Bill Futures
Treasury bills (T-bills) are short-term securities issued by the US Treasury to help finance the spending of the federal government. New T-bills with maturities of thirteen, twenty-six, and fifty-two weeks are issued on a regular basis. The secondary market for T-bills is active, making them among the most liquid of money market instruments.
In May 1972, the International Monetary Market (IMM) division of the CME launched foreign exchange futures, the first financial futures contract. In January 1976, the IMM listed futures contract on 90-day (13-week) T-bills. It was the first futures contract for a money market instrument. Nobel laureate Milton Friedman rang the opening bell on T-Bill Futures launch day.
Upon maturity, seller is required to deliver T-bills with a $1 million face value and thirteen weeks left to maturity. Contracts for delivery in March, June, September, and December are listed. At any one time, contracts for eight different delivery dates are traded.
T-bills do not pay explicit interest. Instead, they are sold at a discount to redemption value. The difference between the two prices determines the interest earned by a buyer. T-bill yields are quoted on a discount basis. Futures contracts are quoted on an index devised by the IMM, by subtracting the discount yield from 100. Index values move in the same direction as T-bill price. A rise in the index means that the price of a future delivered T-bill has risen. The formula for calculating the discount yield is:
Discount Yield = ((Face Value - Purchase Price) / Face Value) X (360 / Days to Maturity)
CBOT Treasury Bond Futures
In August 1977, CBOT launched futures contracts on the T-Bonds.
At the time, the birth of T-bond futures hardly seemed like a breakthrough. Financial futures were still in their infancy. Soybeans and corn were king in the CBOT trading pit.
But all that changed in October 1979 when the Fed moved to strangle runaway inflation with a revised credit policy. The Saturday night massacre, as it was dubbed, ended decades of interest-rate stability. Interest rates bounced like a Ping Pong, affected by money supply, world events and inflation. Trading of T-Bond futures took off like a rocket.
In addition to the traditional T-Bond futures (ZB) with 15-year maturity, CBOT also lists a 20-Yr T-Bond futures (TWE) and an Ultra T-Bond (UB) with 30-year maturity. In the Mid-curve, the T-Note suite includes 2-Yr Note (ZT), 3-Yr Note (Z3), 5-Yr Note (ZF), 10-Yr Note (ZN), and Ultra 10-Yr T-Note (TN).
On December 2, 2022, daily volume of the first T-Bond futures was 388,370 contracts, while open interest reached 1,170,800 contracts. Daily volume of all CME Group interest rates futures and options contracts (IR) reached 13,786,454 lots, contributing to 54.1% of Exchange total. IR open interest was 78,244,297 lots, representing 70.4% of Exchange total.
Cash Settlement Comes to Futures Market
Up until now, futures contracts were settled by physical delivery of the underlying commodities.
• Buyer of 1 CME Live Cattle may pick up 35 cows (40,000 pounds) from Union Stockyard in Chicago southside or take delivery at a cattle auction in Wyoming.
• Seller of 1 CBOT Soybean contract would ship 5,000 bushels of the grain to a licensed grain elevator in Illinois, Iowa, or Kansas.
• For CME Pork Bellies, settlement may involve title changes of warehouse receipt from seller to buyer for 40,000 pounds of the frozen meat in a cold storage.
Even financial futures required physical delivery at that time.
• For British Pound/USD contract, it is £62,500 in pound sterling.
• For Ginnie Mae contract, it is $10 million worth of Ginnie Mae certificate.
• T-Bond futures calls for delivery of treasury bonds with face value of $100,000 and maturity of no less than 15 years.
As we discussed in “The Bogeyman in Financial Contracts”, there is inherent risk in the physical delivery mechanism. No matter how robust its original design is, industry evolution could outgrow capacity, rendering delivery failure under extreme market conditions.
In December 1981, CME launched Eurodollar futures, the first contract with cash settlement feature. Cash settlement alone can be viewed as a financial revolution. Why?
• It significantly reduces transaction cost, which in turn enhances the risk transfer or hedging function in futures.
• It allows non-commercial users to participate in futures. Broader participation improves liquidity, and the price discovery as well as risk management functions.
CME Eurodollar Futures
Eurodollars are dollar-deposits held with banks outside of the US. There are two types of Eurodollar deposits: nontransferable time deposits and certificates of deposit (CDs). Time deposits have maturities ranging from 1 day to 5 years, with 3 months being the most common. Eurodollar CDs are also commonly issued with maturities under a year.
Technically, buyer of Eurodollar future contract is required to place $1,000,000 in a 3-month Eurodollar time deposit paying the contracted interest rate on maturity date. However, this exists only in principle and is called a “Notional Value”. Cash settlement means that actual physical delivery never takes place; instead, any net changes in the value of the contract at maturity are settled in cash on the basis of spot market Eurodollar rates.
Unlike T-bills, Eurodollar deposits, the underlying of Eurodollar futures, pay explicit interest. The interest paid on such deposit is termed an add-on yield because the depositor receives the face amount plus an explicit interest payment when the deposit matures. In the case of Eurodollar, the add-on yield is the London Interbank Offered Rate (LIBOR), which is the interest rate at which major international banks offer to place Eurodollar deposits with one another. Like other money market rates, LIBOR is an annualized rate based on a 360-day year. Price quotations for Eurodollar futures are based on the IMM Eurodollar futures price index, which is is 100 minus the LIBOR.
In the following four decades, all financial futures are designed with cash settlement. Eurodollar futures paves the way for equity index futures, which were launched in February 1982 at Kansas City Board of Trade (KCBT) and April 1982 at CME.
Without cash settlement, can you imagine how to deliver 500 different stocks on a market-weighted basis for the S&P 500 futures? Or 2,000 stocks for the Russell 2000?
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs www.tradingview.com
US Inflation Rate, YoY, Double Top? - Long-term ViewPresently, the inflation rate in the US has started falling, which increases expectations for a pivot - end of interest rate hikes. And factually, we can actually expect it. The supply of M2 Money Stock (M2SL) and its annual growth rate are decreasing. The global economy is shifting, as leading economic index (LEI) indicate. This will undoubtedly put pressure on the Federal Reserve to cut interest rates. However, after the current crisis, the economic recovery will cause a recurrence of inflation. So, if that is the case, the next decade will be marked by tight monetary policy and high inflation. This situation will let the central banks introduce a new monetary system based on CBDCs using incentives such as cheaper credit.
Check also my related ideas. Enjoy
US100 14400 is a bullish targetThe Inverse Head & Shoulders has completed. There will be loads of stops under the right shoulder and the head.
But for now, we have to assume that the pattern is going to play out. In my other research, I detail why fundamentally the Nasdaq should go higher but you would have to dig around and find it on the internet because I am not allowed to tell you where it may be. The reason I put it on a different platform is that I can't upload the charts of my research here! The nut of the thesis is that there is still a lot of money flowing into the markets from the US government.
Targets for a (i)H&S is x2 the distance from the head to the neckline, projected in the direction of the breakout.
Just be on the lookout for a fundamental reason why the algos reverse the price action and attack those stops under the RHS and Head
US30 HTF Analysis Nov 8th 2022From late August to late October us30 was in a bear market rally dropping 5000 pips to pre pandemic highs due to continued FED rate hikes. As FED speakers began to decrease their hawkish tone and discuss their anticipation for less rate hikes in the coming months us30s price began to reflect this as it rejected at the 28900 lows creating a double bottom and forming a demand zone before continuing bullish to now 33100. From this price level if FEDs continue with aggressive rate hikes while Fear, Uncertainty and Doubt (FUD) effect the markets we'll likely see price reject the 33500k key level and begin another bear rally, respecting the overall Higher-Time-Frame downtrend. Or if we see a more optimistic FED impact and continued talks of lower rates than we could likely see price break out above 34000k key level and begin a bull cycle back to ATHs.
US30 HTF Analysis Nov 8th 2022From late August to late October us30 was in a bear market rally dropping 5000 pips to pre pandemic highs due to continued FED rate hikes. As FED speakers began to decrease their hawkish tone and discuss their anticipation for less rate hikes in the coming months us30s price began to reflect this as it rejected at the 28900 lows creating a double bottom and forming a demand zone before continuing bullish to now 33100. From this price level if FEDs continue with aggressive rate hikes while Fear, Uncertainty and Doubt (FUD) effect the markets we'll likely see price reject the 33500k key level and begin another bear rally, respecting the overall Higher-Time-Frame downtrend. Or if we see a more optimistic FED impact and continued talks of lower rates than we could likely see price break out above 34000k key level and begin a bull cycle back to ATHs.
Land of Rising Sun and Falling YenCME: Micro USD/JPN Futures ( CME_MINI:M6J1! )
On September 21st, the Fed raised interest rate for the fifth time. The very next day, Bank of Japan decided to keep the country’s short-term interest rate at -0.10%. On November 3rd, the Fed raised another 75 bps, and the Fed Funds rate is now 3.75-4.00%.
Interest rate spread between the two countries now reaches 4%. With Japan determining to stay accommodative, the rate spread could be over 500 basis points by early 2023.
This is show time for carry trade, a popular and time-honored forex strategy.
What is Carry Trade?
A currency carry trade is a strategy that involves borrowing from a low yielding currency to fund the purchase of a currency that provides higher interest income. This strategy attempts to capture the rate spread, which can be substantial with the use of leverage.
Carry trade is one of the most popular trading strategies in the forex market. In essence, it is as simple as "buy low, sell high”. Popular carry trades involve buying currency pairs such as AUD/JPY and NZD/JPY, since they have decent rate spreads over time.
Profit of carry trade largely comes from its ability to earn interest. Income is accrued every day for holding long carry positions. Below is a typical daily interest accrual formula:
Daily Interest = (IR(long) – IR(short)) * NV / 365
where:
IR = interest rate
NV= notional value
Another source of profit results from the exchange rate changes from the time a trade is initiated to the time it is closed, which could be illustrated by the following example.
DIY Guide for A Synthetic Carry Trade
Assumptions:
1. You have built up $100,000 in home equity from your $500,000 house
2. Foreign currencies can be bought and sold with your bank, without restrictions
3. Home equity loan costs 7.2% annually
4. Borrowing rate for Japanese Yen is 2.2%
Home equity loan rate rose sharply due to the Fed rate hikes. However, since your bank acquires cheap Yen from Japan, they could charge 2.2% and still make money. When you pledge your home as collateral, your yen loan is low risk from the bank’s perspective.
Trade Initiation:
• At USD/JPY rate of 115 (using rate at the end of last year), you borrow 11,500,000 yen from the bank for 1 year, and immediately exchange it into USD 100,000.
• You buy a 1-year Jumbo CD (certificate of deposit) from the bank, which yields 4.2% with a minimum purchase of $100,000.
Trade Closing:
• One year later, unwind the trade.
• Turn your CD in and get $104,200 from the bank.
• You exchange Dollar back to Yen at 150 (recent rate) and get 15,630,000. After paying back 11,500,000 in principal and 253,000 in interest, you net 3,877,000 yen.
• One-year return is 33.7%. Just 2% comes from rate spread (4.2%-2.2%). The rest derives from yen depreciation, which allows you to pay back the loan with fewer dollars.
In this example, we do not use leverage as home equity is in place to fully guarantee the loan. By borrowing with yen, we effectively lower the home equity loan rate from 7.2% to 2.2%. Instead of putting it in CD, you could find more productive use of this low-cost capital, such as paying down a 20% credit card debt.
Usually, interest rate spread is the main income source for carry trades with exchange rate gain as a bonus. With yen dropping to 32-year low, the latter becomes very prominent this year. Borrowing yen from the bank is equivalent to shorting the yen futures.
Hedging the Carry Trade
Most traders work with a forex broker to take on carry trades. Their trades are usually unhedged. Large leverage is used to amplify the returns from small interest rate spreads. In today’s volatile markets, naked carry trades could be very risky. Trades using 50- and 100-time leverage could easily blow up if exchange rate moves against you.
In my opinion, sizable USD/JPY interest rate spread could stay for a considerable period of time, at least throughout 2023. However, Yen may have already bottomed at 150. Bank of Japan has intervened the market by emergency bond buying.
It is a good time to do USD/JPY carry trades. However, it would be wise to protect your positions in the event of a yen rally. Yen lost some 25% against the dollar so far this year. If it rebounds just 5%, it could wipe out all the returns from interest rate spread.
CME Micro USD/JPY futures contract ( CME_MINI:M6J1! ) has a notional value of $10,000. At settlement price of 144.71 last Friday, each December contract is worth 1,447,100 yen. Initial margin is 45,000 yen per lot, or approximately $311.
If you expect yen to appreciate, consider shorting the futures. As it is quoted yen per dollar, rising yen will result in each dollar exchanging for fewer of it.
Happy trading.
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs www.tradingview.com
The Power of PowellCME: E-Mini S&P 500 Futures ( CME_MINI:ES1! )
If the characters of Game of Thrones were on the financial markets, who would be the unchallenged “King of Wall Street” in your eyes?
Since Federal Reserve set sail on tightening monetary policy, all markets fell under the spell of Fed rate hikes. Federal Open Market Committee meetings are major market-moving events. Investors around the world not only watch what the Fed does, but also listen closely to what it says and does not say.
The Fed raised 75 basis points last Wednesday. It is bad news for households and businesses alike. The cost of living and the cost of running a business both went up at the same time. The cumulative effect of +3.75% in eight months has been extraordinary.
Interestingly, US stock markets jumped upon the release of Fed statement. Rate hike of 75 bp was expected, but investors thought they found some signs of Fed softening, which sparked the “Fed Pivot Trade” and pushed the Dow up 400 points and the S&P up 1.5%.
However, when Chairman Powell delivered his speech half an hour later, the market immediately headed to a 4% plunge. His words, “it’s premature to think about pausing”, ditched any hope of easing in the foreseeable future.
What Economic Data?
I have an interesting observation: major economic data has mostly been reduced to a data point for interpreting future Fed decisions.
Discussion of CPI data is not focused on how much food and rent cost went up and why, but whether the decline from 9.1% to 8.2% is sufficient to alter the rate-hike trajectory.
Good non-farm payroll data and low unemployment rate are not celebrated for a strong employment market but being interpreted as the Fed needs to do more.
Corporate profit may be good for a stock, but not for the stock market. If inflation is stubbornly high and six consecutive rate hikes have not cooled down the economy, more tightening is needed.
When interpreting Fed’s policy decision, good could be bad and bad could be good. That is absurd.
Repricing with the Gordon Growth Model
On August 29th, I launched a series on “The Great Wall Street Repricing”. As high interest rate and high inflation rate become the new fundamental assumptions in investing, all financial products would go through repricing.
Based on the Discounted Cash Flow (DCF) Model, a company’s valuation is the present value of its future cash flows. High interest rate raises its cost of capital. High inflation raises its cost of good sold and reduces its sales volume, resulting in lower cash flows. The combined effect is a decline in the stock price. Since high interest rate and high inflation affect all companies, this devaluation applies to stock market indexes as well.
How much will the market decline? This is a $1 trillion question. I use Gordon Growth Model (GGM) to come up with a more quantitative estimate of stock index valuation. The formula for Gordon growth model:
P = D1/(r-g)
Where:
• P = stock price
• g = constant growth rate
• r = rate of return
• D1 = value of next year's dividend
Like DCF, GGM states that the stock's value equals the sum of the present value of future dividends. However, GGM assumes that there is a constant growth in dividends. Free cash flow in the Terminal Period determines the intrinsic value of a company. Let’s see how GGM values $1 dividend per share under various assumptions.
First, we use Year End 2021 data as a baseline case:
• Given that BBB corporate bond rate was below 3%, I assume r = 4%
• Perpetual growth rate g = 2.5%, which is very reasonable
• P = 1.025 / (0.04-0.025) = $68.33
• S&P 500 closed at 4,766.18 on December 27th, 2021
Now, let’s make a forward-looking estimate based on what we know today:
• Fed Funds rate is 4% now, and I expect it to go up to 5% next year
• BBB corporate bond rate is now 6.34%. Adding the expected increase in risk-free rate, I assume the new r = 7.5%
• With a pending recession, dividend growth rate will be reduced to g = 2%
• P = 1.02 / (0.075-0.02) = $18.55
• S&P 500 settled at 3,770.55 last Friday, down 20.9% year-to-date
Based on our GGM calculations, the fair value of S&P 500 index should be at 1294 points, or 73% below its 2021 year-end value. This indicates that the index could fall 2,477 points further from here, or -65%.
GGM is by no means an accurate stock market pricing model. You could twist the assumptions to your liking and come up with very different values. It’s okay that you disagree with the logic behind GGM and prefer a different valuation model.
However, our illustration is a shocking revelation of how vulnerable stock prices are to rising interest rates and slowed growth .
There is a lagging effect in monetary policy. We have not seen the full extent of the impact from rising rates. Companies are partially insulated with fixed-priced costs negotiated from prior year, such as office lease, supplier contract, business loan interest, and wages of existing workforce. However, they will all go up when the contract is up for renewal.
There is another reason for a downward trend in stocks – year-end selling. Many investors have taken a hit of -20% or more this year. They would sell the losers before the end of the year for tax purposes. Institutional investors will also need to rebalance their portfolio at this time. They are highly unlikely to take on new risks.
The bear market is far from over. And the worse has yet to come. Shorting the E-Mini S&P futures ( CME_MINI:ES1! ) is still a viable strategy. Meanwhile, as long as Fed continues tightening the money supply, we’d better buckle up the seatbelt for a bumpy ride.
Happy trading.
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs www.tradingview.com
GBPUSD weaknessThe GBPUSD is moving impulsively.
A break lower than the current intraday low would signal a continuation of this bear move.
The market has sold off continuously since the Bank of England raised rates, and this week is no different.
Can 0.98800 hold in the EURUSD?Waiting to see if the sellers step aside now from the 0.98800 level or whether they fight to keep it during today's NY session.
FOMC raised by 75bps but NFP came in strong. Was the rate hike enough to kill job growth? GDP is being revised higher by the Atlanta Fed too.
Powell will want to see some demand destruction before easing off the rate hikes. US dollar has done well so far.
GBPJPY ShortLooking for a new lower low, to continue the decline of GBPJPY
There is a massive imbalance that the market will look to fill and that ties in nicely with the target for today.
A risk of 1:2 on every trade means we don't need to even get 50% correct and still come out on top.
EURCAD shortI'd only consider going short the EURCAD today. All trades need to be closed by the end of the NY session on a Friday so as not to hold risk overnight.
The ECB is looking for a recession and seems happy to keep killing productivity with rate hikes. The single currency is f'd.
FOMC - NasdaqSo Tuesday, the high of the week? quite possibly.
Wednesday, FOMC and Powell announce a 75bps rate hike. Talks down the market.
Conveniently for anyone that shorted the gap fill, their target of the resting liquidity under the double bottom was realised.
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EURGBP: Pound weaker?EURGBP
Intraday - We look to Buy at 0.8580 (stop at 0.8530)
There is no sign that this bearish momentum is faltering but the pair has stalled close to a previous swing low of 0.8579. We are trading at oversold extremes. This is positive for short term sentiment and we look to set longs at good risk/reward levels for a further correction higher. Further upside is expected although we prefer to buy into dips close to the 0.8580 level.
Our profit targets will be 0.8730 and 0.8815
Resistance: 0.8700 / 0.8815 / 0.8930
Support: 0.8565 / 0.8340 / 0.8200
Please be advised that the information presented on TradingView is provided to Vantage (‘Vantage Global Limited’, ‘we’) by a third-party provider (‘Signal Centre’) . Please be reminded that you are solely responsible for the trading decisions on your account. There is a very high degree of risk involved in trading. Any information and/or content is intended entirely for research, educational and informational purposes only and does not constitute investment or consultation advice or investment strategy. The information is not tailored to the investment needs of any specific person and therefore does not involve a consideration of any of the investment objectives, financial situation or needs of any viewer that may receive it. Kindly also note that past performance is not a reliable indicator of future results. Actual results may differ materially from those anticipated in forward-looking or past performance statements. We assume no liability as to the accuracy or completeness of any of the information and/or content provided herein and the Company cannot be held responsible for any omission, mistake nor for any loss or damage including without limitation to any loss of profit which may arise from reliance on any information supplied by Signal Centre.
ECB Interest Rate Decision PreparationThe ECB is due to release its interest rate decision today 8:15pm (GMT+8)
The current market forecast is for a 75bps hike, taking the interest rate from 1.25% to 2.00%. This decision is likely to have been fully priced in.
The EURUSD had climbed to reach a high of 1.0095 on the back of the DXY weakness and possibly with markets anticipating the 75bps rate hike to come. Currently, the EURUSD is retracing as the DXY recovers by bouncing off the 109.50 price area.
In the lead-up to the news release, I'll be keen to see
1) a deeper retracement between 1.00 and 1.0040
2) price to stay above the parity level
That will allow for a buy-stop order at 1.0050, stop loss below parity and take profit towards the 1.019 60 resistance level, resulting in a 1:2 risk-reward trade setup. If the ECB disappoints, or if the price breaks lower on the release of the news, due to the priced in effect, then I'd cancel the order.
Remember that volatility in the EURUSD will have a significant impact on the DXY, which could affect all major currencies, especially in the short term.
EURJPY:Rate hike push Eur?EURJPY
Intraday - We look to Buy at 145.55 (stop at 144.70)
Selling pressure from 147.70 resulted in all the initial daily gains being overturned. The current move lower is expected to continue. The reaction lower is negative, however, we view this as an opportunity to set longs in line with the overall bullish move higher. We therefore, prefer to fade into the dip with a tight stop in anticipation of a move back higher.
Our profit targets will be 147.95 and 151.00
Resistance: 147.25 / 151.00 / 155.00
Support: 144.30 / 141.70 / 138.85
Please be advised that the information presented on TradingView is provided to Vantage (‘Vantage Global Limited’, ‘we’) by a third-party provider (‘Signal Centre’) . Please be reminded that you are solely responsible for the trading decisions on your account. There is a very high degree of risk involved in trading. Any information and/or content is intended entirely for research, educational and informational purposes only and does not constitute investment or consultation advice or investment strategy. The information is not tailored to the investment needs of any specific person and therefore does not involve a consideration of any of the investment objectives, financial situation or needs of any viewer that may receive it. Kindly also note that past performance is not a reliable indicator of future results. Actual results may differ materially from those anticipated in forward-looking or past performance statements. We assume no liability as to the accuracy or completeness of any of the information and/or content provided herein and the Company cannot be held responsible for any omission, mistake nor for any loss or damage including without limitation to any loss of profit which may arise from reliance on any information supplied by Signal Centre
US30 Weekly Forecast 10/16/22I think it is pretty safe to have a sentiment about US30 being bearish for this upcoming week. The Fed has yet to let up on the never-ending rate hike which is causing huge fundamental movements like the ones we have seen last week. We have hit a pretty strong supply area with a notable key level for U30. I definitely would like to reanalyze this pair in the middle of the week just in case more economic factors come into play. As a trader, you should always be able to change your analysis at a drop of a hat. :-)
Today is the Best Day in the Next 12 MonthsWhat We Expected
When the ball dropped in Times Square at midnight December 31st, we had very good reasons to cheer for Year 2022.
S&P 500 ended 2021 at 4,766.18, up 27%. In fact, the index was more than double in a 2-year bull market since the pandemic drove it down to 2,230 in March 2020.
U.S. Bureau of Labor Statistics (BLS) reported monthly growth of nonfarm payroll by 648K, 249K and 199K in October to December, respectively. U.S. regained 18.8 million jobs since April 2020. This accounted for 97.7% of the total job losses due to the pandemic.
BLS also reported the Consumer Price Index (CPI) at an annual rate of 7.0%. AAA regular gasoline retail price averaged $3.28 a gallon nationwide for the last week of December.
Fed Chairman Jerome Powell insisted that inflation was “transitory”. Firstly, this was due to the bottleneck in the global supply chain, which had been disrupted by the pandemic. But we were already coming out of the pandemic. Global trades would be normal again soon.
Secondly, Congress passed a $1.9 trillion stimulus bill in March 2021. Pumping money in the financial system obviously pushed demand and price-level up. After all, most of us could afford higher prices with the $1,800 stimulus check from the Trump Administration and $1,400 more thanks to President Biden.
Meanwhile, Fed Funds rate was at its lowest level in 0%-0.25% range. Thirty-year fixed mortgage rate averaged 3.11% at the year-end 2021, according to bankrate.com.
What Actually Happened
Fast forward to October 13th 2022. BLS reported a higher-than-expected CPI at 8.2% annual rate in September. The Core CPI, which excludes foods and energy, ran at 6.6%, its highest level since 1982.
When U.S. market opened, S&P 500 dropped below 3,500. While it posted a historic turnaround later in the trading session, it proved to be a “dead cat bound”. On October 14th, the S&P fell 2.37% and closed at 3,583.07. This is a year-to-date return of -25.3%.
Since March 2022, the Fed has engineered five consecutive rate increases. Fed Funds rate is up 300 basis points to 3%-3.25%. More rate hikes are expected at the November and December Federal Open Market Committee meetings. After all the rate increases have been completed, the terminal rate is widely believed to be above 5%.
Thirty-year fixed mortgage rate is now 7.73%, a whopping 4.63% higher compared to the end of last year. Home ownership is increasingly out of reach for young adults.
Central bank tightening has not yet cooled the runaway inflation. Reading the CPI data by category, you will find that everything went up except for gasoline and diesel. However, gas has bottomed in September and has been creeping up in the past three weeks. So has diesel. Without their offsetting, inflation is likely to stay high in the coming months.
We are on the verge of a recession. The question is not if, but when and how deep. The global economy faces strong headwinds:
• High interest rates
• High inflation
• A regional war that lasted eight months with no end in sight
• An energy: Russia turns off natural gas and OPEC+ cuts oil production
• Political uncertainties: US midterm election, new governments in the UK and Italy
Stock Index Trade Ideas
In the past five months, I discussed 20 trade ideas on TradingView, ranging from equity index to interest rates, foreign exchange, energy, metals, agricultural commodities, and cryptocurrency. Let’s revisit three ideas on stock indexes and see if they still make sense today.
“Bear Market is Far from Over” was published on June 22nd. I suggested that the S&P would test its support line at 3,383, its pre-COVID peak. Thursday’s low was within 100 points from reaching this level! Mindful that this occurs when the US economy is still growing. Imagine where the S&P would go when we are in a recession.
In “The Great Wall Street Repricing”, I used the Discounted Cash Flow model to illustrate why the stock market has to fall.
• High interest rate raises the weighted average cost of capital (WACC). It enlarges the denominator of the DCF equation and makes the present value smaller.
• High inflation increases the cost of goods sold. Higher price tends to reduce demand. The combined result is lower free cash flow and a smaller numerator of the equation.
Seven weeks after publishing this idea, I observe that both interest rate and inflation rate are higher than originally expected. So the repricing impact would be even bigger.
At “Tale of Two Americas”, I explained why Small-Cap index Russell 2000 could fall harder than the Blue-Chip S&P 500 during a recession.
• The component companies in the Russell 2000 have lower credit ratings and higher WACC
• Recession would have a bigger impact on the revenue and profit of smaller firms
• Russell has lofty P/E ratio. The bubble would burst in an economic downturn
Bearish Trading Strategies
Three strategies for your consideration: 1) Short the S&P 500; 2) Short the Russell 2000; and 3) Long the S&P-Russell Spread.
CME S&P 500 Futures ( CME_MINI:ES1! )
ES is one of the most liquid equity index futures contracts. It traded 3.3 million lots last Thursday. If you bark at its $10,000 initial margin, try the Micro E-Mini S&P ( CME_MINI:MES1! ). It is 1/10 the size of ES and requires only $1,000 in margins.
When is a good time to short? I would wait for a bear market rally like last Wednesday. There will be many of them. Investors are hopelessly romantic with stocks. A better-than-expected company earnings, or a less hawkish tone from the Fed, could be interpreted as good news, even for a one-day wonder.
CME Russell 2000 Futures ( CME_MINI:RTY1! )
RTY traded 324,814 lots last Thursday. The index is more overpriced than the S&P and we could make a bigger payday shorting it. Initial margin is $5,500. Similarly, the Micro E-Mini Russell ( CME_MINI:M2K1! ) is 1/10 of RTY and requires only $550 in margins.
As with the ES, I would wait for a rebound before putting in a short RTY position.
Long ES-RTY Spread
If you are not comfortable with an outright short futures trade, consider the spread between S&P and Russell index futures. I expect the price gap to get wider as the more overpriced Russell falls faster than the S&P.
What’s the appropriate long-short ratio? Initial margins for MES and M2K are $1,000 and $550, respectively. Long 1 MES and Short 2 M2K would do the trick.
Financial market is extremely volatile this year. Getting an information edge increases your odds of success in managing risk. I suggest leveraging real-time market data for a better gauge of market situation. TradingView users already have access to delayed data. A Pro user could upgrade to real-time CME market data for only $4 a month, a huge discount at the time of high inflation.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
USDCAD: Buy dips!USDCAD
Intraday - We look to Buy at 1.3475 (stop at 1.3415)
Previous support located at 1.3550. Previous resistance located at 1.3600. We expect a reversal in this move. Risk/Reward would be poor to call a buy from current levels.
Our profit targets will be 1.3595 and 1.3600
Resistance: 1.3600 / 1.3650 / 1.3700
Support: 1.3550 / 1.3500 / 1.3475
Please be advised that the information presented on TradingView is provided to Vantage (‘Vantage Global Limited’, ‘we’) by a third-party provider (‘Signal Centre’). Please be reminded that you are solely responsible for the trading decisions on your account. There is a very high degree of risk involved in trading. Any information and/or content is intended entirely for research, educational and informational purposes only and does not constitute investment or consultation advice or investment strategy. The information is not tailored to the investment needs of any specific person and therefore does not involve a consideration of any of the investment objectives, financial situation or needs of any viewer that may receive it. Kindly also note that past performance is not a reliable indicator of future results. Actual results may differ materially from those anticipated in forward-looking or past performance statements. We assume no liability as to the accuracy or completeness of any of the information and/or content provided herein and the Company cannot be held responsible for any omission, mistake nor for any loss or damage including without limitation to any loss of profit which may arise from reliance on any information supplied by Signal Centre.
Long on NAS100 until NFP?As per Fed's Daly remarks states that the US needs further rate hikes to combat inflation hence why this current rally on indices and today's miss on JOLTS jobs report. Markets are continually providing volatility which equates to more opportunities for all market instruments. We have been breaking structure to the upside on NAS100 since Monday and all throughout the asian session. I've adapted a short term sentiment to bullish with a final TP 11760.1 I do believe we will see bearish plays come back in on NFP day.
I will act accordingly to what the market shows.
U.S. Dollar moment of truth is here!Traders,
Since 2009 the dollar has remained under this purple trend line. Today we do battle. This is the moment of truth! A cross above it (unexpected) would be bearish for our U.S. stock markets. If we stay below? I expect good things in the next several months.
