Artillery Fire Setting the Stage for an Economic Bombshell from the Fed

Artillery Fire Setting the Stage for an Economic Bombshell from the Fed

North Korea fired missiles into South Korea today.

The markets are a bit shaken up – the Korean won is down more than 3%; the US dollar is the recipient of some safe-haven flow; the S&P 500 futures are down about 1% at writing.

Last week we mentioned that the risk-bid for the US dollar – a sustained move higher for the buck based on a dramatic shift in consensus sentiment – was very much in play considering the Ireland & Co. fiasco, plus the outlook for China to really tighten down on its major growth drivers in an effort to stem overheating.

Now add geopolitical conflict to the list. Typically this fear seeps into broad market concerns, just as it appears to be doing so far today; and the US dollar still possesses a modicum of safe-haven merit.

Dollar Index Daily: Chart resistance 7960-7978…working higher out of the downtrend channel.

Today’s US preliminary Q3 GDP report came out and it’s a tick better than expected; although corporate profits grew at a very disappointing 1% versus expectations for 3.6%. The latter seems to have had a kneejerk impact on stock futures.

What might have a broader impact, though, are the Federal Reserve minutes from their early-November meeting where they officially introduced QE2. The minutes are to be released this afternoon. Expectations are for a downgrade of the US economy by the Fed, according to a well publicized story in the Financial Times yesterday.

And if that outlook catches the market off-guard, two potential scenarios could unfold:

1) The US dollar falls because of the deteriorating US growth differential among its major competitors, specifically Eurozone, UK, Japan, as the US economy stumbles along; but, given the growth prospects elsewhere that might be tough to achieve. Granted, Germany still posted good numbers. But it is clearly a two-track economy in the eurozone—Germany and all the rest. The latest Irish wrinkle cannot be good for growth; today’s positive report from the eurozone must be seen as “very” rearview mirror stuff.

We continue to prefer watching the yield differential between the eurozone and the US. It has blazed a clear positive correlation path so far, i.e. falling US yield differential equal falling dollar and vice versa. Now we are in vice versa territory with US yield differential rising since the “official” QE2 launch.

2) The US dollar catches additional safe-haven money flow, to a greater degree than right now. The specter of a double-dip in the US isn’t good for anyone. Europe needs China to buy all the German stuff; while China needs the US to buy all that Chinese stuff. Was the surprise technical recession reported for the third quarter in Thailand telling us something about China? Hmmm…

Thailand GDP (Malaysia similar trend as reported yesterday): This is a surprise given the liquidity flushing into the region.

It is always interesting how sentiment can seemingly change on a dime. The stock market still appears a bit complacent about all this stuff. Hmmm …

Volatility Index Daily: New intermediate-term low on Friday (going back to April)…not much different yesterday.

Hmmm … April? April? What happened in April? Oh yeah, that’s when stocks got crushed!

VIX (black) vs. S&P 500 (red) Index Daily: When VIX swerved to a new low in April, Mr. Market pulled out the Joker card—slam!

And of course, we have been watching this very tight correlation …

S&P 500 Index (red – top) vs. US $ Index (green-bottom):

And if today doesn’t provide enough fire power, tomorrow the US reports all kinds of economic data ahead of the Thanksgiving holiday – weekly mortgage market data, consumption, PCE, durable goods, jobless claims, personal income, consumer sentiment surveys, house prices and new home sales .

Stay tuned.