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Vol To Stay Elevated Against Ongoing $ Strength/Pre-Election Uncertainty - Weekend Macro Press

Key Tactical Takeaways:  

> The recent $ breakout has left G7 currencies littered with popular topping patterns (ex. the yen) that have yet to reach their downside potential. In addition, dollar bears actually increased their extreme bearish $ bets this past week, increasing the potential for more squeeze-driven $ gains.


> We expect that both agricultural and industrial metals are transitioning from periods of rapid appreciation to extended periods of consolidation, after this past week’s swift downside reversals were preceded by extreme short hedger positions across many of the underlying constituents.


> With the dollar finally showing some authority after several weeks of uncertain bottoming action, EM, BRIC and FM are expected to underperform the S&P over the near-term.


>  We are watching EFA (developed equity markets ex. North America) very closely, as the pattern suggests any short-term rebound should be used to build bearish positions.


Market Outlook:

After 20 years of trying to predict future price action in markets, it still makes me a bit nervous when a corrective forecast plays out in a textbook manner. The anxiety level increases even more when these forecasts near completion at a time when both the fundamental and macro pictures don't support the idea that the prevailing price trend is about to resume.


When we look at the US equity market, we see that the anticipated correction from the 09/02 cycle high has now unfolded as a classic 3-wave decline of 10% on the benchmark S&P 500. While the measured potential of this pattern ..., Friday's closing rally above the 1 ATR trailing stop is an indication that participants understand the importance of the current zone of support, and are eager to leg back into longs. Fundamentally, though, with the threat of renewed Covid-related lockdowns looming, the recent rollover in key economic prints warning that the fast growth phase of the recovery has peaked, credit stress starting to surface a bit as spreads rotate to multi-week wides, European banks showing real signs of distress, the domestic equity seasonal pattern weighing for another couple of weeks , our base case is that the S&P 500 is setting up for a pre-election range trade, not a straight shot to new highs.


We're keeping it very simple this week and focusing on the daily chart of the iShares Iboxx High Yield Corporate Bond ETF. As part of the Fed's Covid-related emergency programs, we know that investment grade bonds will be supported when needed, leaving higher yielding debt of riskier companies at the mercy of the market. That said, everyone should be keeping a close eye on high yield debt vehicles such as HYG in coming weeks, after confirmation of an intermediate top this past week.  If equities start to show positive rotation without confirmation from HYG at some point leading up to the election, or if HYG starts to show leading deterioration ahead of the S&P, this will be a red flag for equities. For now, though, we only see reason for participants to operate with caution.


From a macro perspective, one thing that has remained certain during this great period of market uncertainty has been the dollar's strong inverse relationship to the US stock market. Therefore, the fact that the dollar index still has measured upside potential to ... and an almost endless supply of bearish sentiment to possibly fuel an even larger rally is another key reason the S&P 500 is at risk of a choppy environment.


Bottom Line: This week, equity shorts should take tactical profits anywhere between .... Although the dollar may experience some fast-money profit taking, use dips to add to long dollar/short G7 currency (ex. yen) bets and add to EM/BRIC underweights. Lastly, any rebound in EFA (developed equities ex. N. America) should be used as a means to enter shorts.


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