Andy Krieger's Thoughts on the Market - 19 November 2023

In the past month, we have seen quite a number of interesting moves in the markets. The moves have been powerful and spread across many different asset classes. I think it is a good time to assess where we are, where we have come from, and where we are likely heading. Let’s start with a review of some of my prior forecasts.

In prior write-ups, I had called for euro/cad to top out around 1.5100 and head back towards the 1.4200-1.4300 levels prior to re-challenging the 1.5100 highs. The sell-off from 1.5100 ended up stopping around 1.4160 in late September before beginning its next climb. The rally since then has been steady and quite powerful. The euro/cad currency pair has strengthened back above 1.5000 today, and although the cross will almost certainly fail at 1.5100-15200 on this initial attempt, I think there is a good chance that it will take out that level and rally up towards the 1.6000 level. Depending on how the fundamentals play out, I wouldn’t be surprised to see an ultimate rally towards the 1.7500 level, but that will take a long time.

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Dollar/Canada and the Canadian dollar crosses tend to trade at a low volatility, so these moves have not been fast, and they generally won’t be fast going forward, but for the patient trader, these trades have certainly been worth the wait. A variation of this trade that is even more interesting is cad/chf, as I think that the Canadian dollar will continue to weaken against the Swiss franc. The pair has broken through major support and is now trading at an all-time low below the prior low of .6475. I don’t have a specific downside target in mind, but I wouldn’t be shocked to see it drop as much as another 10%. The magnitude of the move will depend on a variety of factors, so this is a trade in which I would just place a trailing stop and ride the trend. I will revisit this trade in more depth shortly.

In gold, as noted previously, we got the corrective sell-off back to the $1810-$1820 level from above $2000, and I think we are in the early phase of a major new rally in gold. My minimum target would be between $2270 and $2320. Again, we need to take it one step at a time, but things are setting up nicely for this trade to continue.

Just touching briefly on the fundamental picture in the U.S., it wouldn’t be very difficult to describe a scenario in which the U.S. fiscal time bomb coupled with very sticky inflation creates the perfect conditions for gold to surge higher. The U.S. will have to pay over $1 trillion dollars next year just to cover its interest payments, and this number is growing every year. The Treasury and the Fed have been kicking this can down the road for a long time, easing monetary conditions and spending money wildly at the fiscal level at the first sign of any economic weakness, but I am concerned that the can is now filled with explosives that could ignite and explode under the right (or wrong) conditions.

The Fed’s balance sheet is staggeringly large, and the Fed still has a huge amount of reducing to get its balance sheet anywhere close to where it was prior to Covid. The equity markets are joyfully anticipating Fed interest rate cuts beginning in earnest next year, totally ignoring how quickly interest rate cuts could trigger a resurgence in inflationary pressures which have kindly eased to awful levels from the hideous levels they were at previously.

On the fiscal front, Congress shows little or no interest in behaving in a manner that is remotely fiscally responsible. Moreover, the infantile in-fighting in Congress is simply another potential time-bomb that could easily lead to a host of additional, ugly fiscal developments, and the Congressional impasse could worsen next year due to the elections.

Going forward, I am not sure what the trigger will be that finally shifts the equity market dynamic to one in which bad news is actually bad for the market. Thus far, we have seen time and again that bad news is met with surges of stock buying as the market anticipates the Fed will come racing to the rescue with plentiful liquidity and lower interest rates. What I know is that at some point that relationship will shift, and the equity markets will have one almighty decline. In the interim, buyers jump in on every sign of economic weakness, so I suppose the markets will need to make new highs before a sustained sell-off can occur. My bearishness in stocks has thus far been more strategic from a trading perspective, covering shorts after vicious, short-lived declines. It is too early for the structural sell-off, but many of the seeds are in place. We just need to be a little more patient.

In bonds, my target for the 30-year yield was around 5.3%. We got to 5.18%, having surged over 100 basis points in just a matter of weeks. I think that the recent move lower in yields is corrective, but I am not sure. I covered my bullish bet in the 30-year yield, and I am just watching the market right now. I see some economic softening and a slightly softer Fed, but I can still easily envision trouble in the bond market.

In Natural Gas I am also flat now. I covered the balance of my long position when the market reversed from the $3.50 level. It put in a double-top up there, so I figured it was time to bail. From the bottom to the recent high, we had an 80% rally, which is more than enough to warrant a flattening of the bullish bet.

Next, I need to also address the yen, which I have frankly been fighting for months. The market has a massive, short yen exposure now, having piled into the short yen carry trade quite effectively. The interest differential is still very large, but it has narrowed a bit recently. More importantly, it seems that the thirty plus years of deflationary pressures in Japan are finally easing. To break the deflationary cycle, Japan has required an almost unimaginably large amount of intervention by the Bank of Japan, but the end of the quantitative easing may finally be near.

The market conditions are almost perfect now for a vicious reversal in dollar/yen, with the pair having failed multiple times to take out the prior highs at 151.95. We opened today in Asia at 149.70, and the dollar is starting to look quite heavy. Being short dollar yen is a hard trade, but the short yen bets in the market are dramatically over-crowded. Once the move lower is confirmed, and this confirmation is close, my initial target on the downside over a few weeks of trading would be around 137.40, near the lows of July. The move should be fast and violent, as progressive stop loss orders lead to an accelerating decline. I think the best way to play for this move is through limited-risk option structures, with a fixed dollar investment versus an enormous upside return if the dollar/yen selloff develops as anticipated. I had expected this surge in the yen to be triggered by a significant risk-off scenario in the global markets, but maybe it simply starts as a technical adjustment that starts to snowball.

I intend to write again shortly to address the recent sharp reversal in the dollar against the pound and the euro, but I want that discussion to be a separate write-up. I also want to address the macro environment for future developments regarding inflation, as I believe the markets are undervaluing the structural risks going forward.

In the interim, I wish you all the best of luck with your trading.

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