Hold Your Breath

As record heatwaves ravage the Eurozone, the ECB is similarly turning up the heat - on the European economy. The monetary managers of the rickety construct known as the European Union are far behind the curve on the 'price stability' side of the ledger. They have no choice but to hike 50 basis points this week, as reports this morning are predicting. To the average euro-consumer, it will be like holding their head under water when they are already out of oxygen. My advice- hold your breath.

Can the European economy actually avoid a recession given the rate hikes are piling bad news on an already messy outlook? Should the energy costs not subside and create further demand destruction, it won't. A welcome bounce in the euro is shaping up this morning on the back of the ECB leak, but it is tentative and looks suspiciously like short covering.

Meanwhile, most markets are treading water in front of the Fed summer meeting and an earnings season that will be forensically scrutinized for clues about the state of corporate health. Encouragingly, risk markets dug in their heels last Friday and have held important levels despite yesterday's late-day reversal. The contrarian buoyancy of the market is likely a function of the extraordinary pessimism being exhibited by market participants and commentators. The BofA fund manager survey this morning showed the highest cash holdings in 20 years. If it wasn't for bad news, there'd be no news at all.

Remember, I think "bad news is good news" - at least for markets.

I'm watching bonds and Financial stocks for a tell on the market. Investment grade bonds are at attractive spreads for the first time in years and are getting bids. Yesterday's reversal of the high yield ETF - $HYG - while disconcerting did not follow through to the downside this morning. Small caps - as I flagged last week - seem to be holding up relatively well. If market-driven rates hold these levels as the Fed finishes up its hiking cycle, I think we can rally out of the hole that the pessimists have created for us.

I'm not betting the farm here, but given the chance that we get a 'better than feared' earnings season and some better news on the energy cost front, I like our chances here. The Fed needs to deliver a dovish hike as well. If Russia restarts Nordstream 1 and lets Germany fill their gas reservoirs, that's even better. The 'Fed Put' is gone but can we get a 'Putin Put' as a replacement?

That's a lot of 'ifs' for the market. But when your head is being held underwater, any bit of oxygen is welcome.

Risk Model: 2/5 - Risk Off

Curiously the AAII Sentiment indicator has gone positive (albeit tentatively) in the face of all the pessimism. It joins the now subdued VXV indicator in a bullish position. Remember that the AAII Sentiment component is a function of its position relative to the 30-week moving average. It looks from the chart (below) that readings have been sufficiently negative for long enough to lower the bar and allow for a positive signal. Interestingly, the 30 wk ma has been falling for over a year now. Nobody is left to sell now. That's what this market feels like. So bad it's good!