Over the last several weeks seasonal, technical and fundamental signals have all been flashing around US stock markets and this week, it appears that equity traders have finally woken up to reality and a correction appears to be getting underway.
August and September have historically been two of the worst months for the year but this year, the seasonally weak period started with some US indices driving to new all-time highs. Over the last few weeks signs of topping have appeared and breadth has shifted from bullish to bearish with the Russell 2000 leading the way down.
Today’s declines could be blamed partly on softer than expected manufacturing PMI and construction spending but the main reason appears to be the realization setting in that the liquidity party (QE3) is coming to end later this month, unless the ECB announces a massive program of its own tomorrow. Following the end of QE1 and QE2 US indices fell over 10% within three months even with interest rates low.
This time around, the pressure remains on the Fed to raise rates sooner. ADP payrolls improved slightly, indicating that last month’s nonfarm payrolls were likely distorted and could be revised upward on Friday. Meanwhile, the prices component of the ISM report indicted growing inflation. The huge USD rally of the last two months indicates currency traders have been anticipating a more hawkish Fed going forward, but stocks had been ignoring this until the last week or so.
USD paused indicating that its rally had already priced in the payrolls news. This enabled AUD, NZD and CAD to stabilize. Gold bounced back a bit. Crude Oil did as well early on boosted by another drop in inventories but was not able to hold on to the gains.
The main event tomorrow is the ECB meeting and press conference with the central bank expected to outline its asset purchase plan tomorrow which could have a big impact on the trend in EUR. The single currency has fallen off dramatically in recent weeks indicating the street is expecting the ECB to come up with something big.
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