The Trend Is Your Friend Until It Isn't: Reflation Trade Might Be Over
Chris Vermeulen | Jun 16, 2021 11:36AM ET
Over the past few weeks, we have watched the markets continue their attempt to melt higher. Recently the Dow Jones and the Dow Jones Transportation have breached lower upward sloping support channels that suggests traders are preparing for a surprise Fed statement or a breakdown in the current bullish price trend. My team and I believe this warning sign may be suggesting the reflation trade is over. Traders believe the U.S. Fed will soon begin to act to contain inflation by raising rates.
As we move closer to the FOMC statements and decisions related to the economy, inflation and future expectations, the U.S. major indexes usually move into an apprehensive sideways trend. This happens because U.S. federal reserve decisions can have a very big impact on how consumers and corporations perceive monetary policies and future opportunities. The U.S. markets will likely react to the U.S. Fed statements this week with increased volatility and trend strength. If you have not already protected your trades in preparation for the FOMC comments this week, get ready for a potentially wild ride.
h2 Fasten Your Seat Belts And Make Sure You Have Your E-Tickets Ready/h2The Dow Jones Industrial Weekly chart below shows how price has been moving higher (melting upward) throughout the early part of 2021 and has just recently broken below the YELLOW upward sloping price channel line. It is our opinion that this move, below a key support level, may be an early indication that traders and the markets expect a policy change from the U.S. Federal Reserve. Quite possibly, the inflationary aspect of the recovering global economy is sparking greater concern for the U.S. Fed and it may decide to act in steps that will help curb run-away inflation earlier than expected.
We'll know soon enough as the FOMC statement is due on Wednesday, June 16, 2021. We are expecting an increase in volatility with the potential of the FOMC comments driving a new upward or downward trend. If the Fed issues a statement where it is taking no action and doesn't believe inflation is a core issue, then the markets will likely continue to move higher. If the Fed issues a statement that inflation and other concerns are big enough to warrant a surprise rate/policy change, then the markets may react to the downside.
This next Weekly Transportation Index chart highlights a similar type of price pattern. The Transports have broken below a more recent upward sloping price channel, from the February 2021 lows, and has yet to break below the major upward sloping price channel line, from the COVID-19 lows. Still, this “rollover” in the Transportation Index suggests traders are changing perspective related to future economic activities 90 to 120+ days into the future. This sideways rollover suggests traders believe the commodity rally and inflationary pricing pressure will “abate” as we move into the end of 2021.
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Logically, we would expect the Transportation Index to continue to move lower if these expectations become rooted in the broad market perspective. If the Fed takes any action to help curb inflationary expectations, this downward trend in the Transports could move in a much more aggressive manner.
Are the Dow Jones Industrial Average and Transportation Index setups warning that the Fed may be backed into a corner? Are we starting to see a change in trader/investor sentiment related to the current commodity rally and/or economic activity throughout the rest of 2021? Only time will tell at this point.
What we do know is that later today, being Wednesday, June 16, the FOMC decisions and statement will likely set a tone in the markets that will drive increased volatility and trending. This could prompt some very big trends in major market sectors such as precious metals, oil and others. Now is the time to get ready for some bigger trends that will likely last throughout the rest of 2021 and into 2022.
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