Technical Analysis and The Economy

Rectangle Chart Pattern: A Picture of Economic Uncertainty | IJS Speaks

September 18, 2023 IJS Speaks Episode 42
Technical Analysis and The Economy
Rectangle Chart Pattern: A Picture of Economic Uncertainty | IJS Speaks
Show Notes

The last 18 months have been a rollercoaster ride across financial markets, but in the grand scheme of things markets really haven't gone very far, and in most cases sideways ranges have emerged as a result of all the volatility. In the world of Technical Analysis, this type of price action creates a Rectangle Chart Pattern. This type of consolidation can  occur at the end of a trending market, when buyers and sellers get to a point of indecision. Past the point of indecision, a breakout of the range in one direction or the other signifies a continuation of the previous trend, or a possible reversal. 

The dollar rocketed higher while the Fed raised short-term rates by 75 bps for most of 2022 and into 2023. The dollar index reversed course as the Fed down-shifted from 75 bps rate hikes to 50 bps, which then consolidated into the lower-bound of the rectangle pattern. Now, as the narrative of a 'soft landing' for the US economy becomes more commonplace among some market participants, the dollar appears to be moving from the bottom of its rectangle towards the top. This repricing of the dollar reflects falling inflation in the US paired with a resilient labor market. The dollar can be expected to continue to rally, if inflation stalls-out before getting back to the Fed's 2% target and unemployment remains subdued. This leaves the door open for the Fed at any point to surprise markets with some type of policy tightening.

The market for Gold has been consolidating for the longest of all the markets I follow. The rectangle chart pattern starting forming in late 2020 for gold, and has been very well defined. Within the last 18 months, gold and the US 10 Year Treasury spent a considerable amount of time trading with a strong positive correlation, especially once the Fed embarked on the current rate hiking cycle. From its current level, gold can be expected trend lower as rates remain elevated and central banks keep downward pressure on inflation. In this environment, gold loses luster as an inflation hedge and as the opportunity cost of higher yields cumulate.

The US 10 Year Treasury market is at the point of breaking out of the rectangle chart pattern, but the trade setup suggests higher interest rates are on the horizon. The downtrend in price leading to the rectangle chart pattern was made up to two Bull Flag Patterns, so a breakdown of the rectangle could mean a return of downside momentum in fixed income markets. The strong positive correlation shared by Gold and the US10YR also suggest that the government bond market may experience selling pressure in the near-term, as Gold charts are also signaling selling pressure in the near-term.

The Oil market is always an interesting one to follow. A lot can be inferred from the price of oil about industrial activity globally, when adjusted for geopolitics. And if nothing else, the volatility can make your head spin. The market trended up from the lows of the COVID lockdowns when Russia and Saudi Arabia dumped oil on the market to bankrupt US shale producers, to the highs made post the Russian invasion of Ukraine. Then the market became concerned about the outlook for the Chinese economy and the Biden administration opened the taps on the US Strategic Petroleum Reserve so prices retraced. This setup the Rectangle Chart Pattern when the market started rebounding on news of Saudi and Russian production cuts and subsequent extensions of those cuts. 

At current levels of consumer and industrial demand for energy, the production cuts planned by OPEC+ will continue to build a shortage into the near-term. Consumer spending in Europe is most likely the linchpin maintaining upward pressure on oil however. If Europe continues to slow, so will demand for Chinese exports and Chinese industrial demand for energy, which can take some steam out of the move higher in oil.

The equity market, proxied by the SP500 rocketed higher from the lows ...