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S&P 500 And 10-Year Treasury Notes Short-Squeezed After BOJ Says Interest Rates To Go Negative

|Includes: BHC, ESRX, SPDR S&P 500 Trust ETF (SPY), VZ

by Ed Wijaranakula, NMS Investment Reserch

The S&P 500 gained another solid 2.48% on Friday, the second Friday in a row, to close at 1,940.24, after the Bank of Japan (BOJ) said following its two-day rate review that they will introduce quantitative and qualitative monetary easing (QQE) and apply a negative 0.1% interest on excess reserves (IOER) of financial institutions placed at the bank, effective February 16. The BOJ also said it left the buying program of government bonds and exchange traded funds (ETFs) unchanged.

Japan's inflation was still near zero ahead of the BOJ's two-day rate review. Last Friday, BOJ Governor Haruhiko Kuroda said during an interview with Bloomberg in Davos that the BOJ was prepared to expand bond purchases if necessary to achieve its 2% inflation target.

The headline news sent the yield of the U.S. 10-Year Treasury Notes tumbling 3.0% on short-covering, to close at 1.94% on Friday. The BOJ move signals that interest rates aren't going up soon and it's time to cover treasury short positions, as the strategy with rising rates is to short the treasuries.

As of January 26, there are 668,701 short positions of 10-year U.S. Treasury Notes, traded on the Chicago Board of Trade (CBOE:TNX), by leveraged funds, where TNX contracts are traded in units of $100,000 face value. This is compared to about 452,347 long positions, according to the Commitment of Traders data released by the Commodity Futures Trading Commission (CFTC). Although hedge funds have been adding to their long positions of treasuries, resulting in an increase in the net long positions by about 19,889 contracts last week, the funds could reduce their short positions further in response to the BOJ move.

The sinking yield of the 10-year U.S. Treasury Notes could be due in part to weak U.S. economy data, as the Commerce Department said on Friday that the advance estimate of gross domestic product for the fourth-quarter 2015 was 0.7%, missing economists' expectations of a 0.8% gain. For the full-year 2015, the economy grew 2.4%, unchanged from 2014. Separately, the Commerce Department said Thursday that durable goods orders tumbled 5.1% last month, after declining 0.5% in November. Economists polled by Reuters had forecast durable goods orders to fall just 0.6% in December.

As expected, the U.S. Federal Reserve did not raise interest rates on Wednesday, but gave no indication whether the FOMC would change its views on rate-hikes, despite the turmoil in the global financial markets. The Fed issued a statement saying that they were "closely monitoring global economic and financial developments". Also in the statement was, "Inflation is expected to remain low in the near term, in part because of the further decline in energy prices, but rise to 2% over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further,".

U.S. financial markets sold off immediately after the release of the Fed statement, as the Fed move was perceived as hawkish. Some analysts think the policy statement was dovish and in line in with their views. The probability of a rate hike at the next FOMC meeting on March 16, based on the 30-day prices of federal funds futures, traded on the Chicago Mercantile Exchange and commonly used to estimate the market's views on the likelihood of changes in U.S. monetary policy, is only 16%, according to data from the CME Group as of January 29.

According to the Commitment of Traders data released by the Commodity Futures Trading Commission (CFTC) for the week ended January 26, there are 143,956 short positions of S&P 500 consolidated futures, traded on the Chicago Mercantile Exchange (NASDAQ:CME) by leveraged funds, an increase of 1,314 short positions from the previous week. This is compared to about 74,641 long positions, an increase of 10,987 from the previous week. Although, the data suggested that hedge funds increased their net long positions of S&P 500 consolidated futures by about 9,678 contracts, the ratio between short and long positions is still almost 2, where contracts of S&P 500 futures are traded in units of $250.00 x S&P 500 index.

For the week, market uncertainty and short-covering sent the yield of the 10-year U.S. Treasury Note down 6.66%, to close at 1.92% on Friday, while the yield of the U.S. 2-Year Treasury Note tumbled 10.88%, to close at 0.778% on Friday. The yield spread between the 10-year and 2-year Treasury Notes printed at 1.15 percentage points on Monday, a level not seen since early 2008. The U.S. dollar index (DXY), a weighted index of the value of the U.S. dollar relative to a basket of six major currencies, went nowhere as it closed practically unchanged for the week, at 99.652 on Friday.

The S&P 500 closed at 1940.24 on Friday, up 1.75% for the week. The best performing S&P 500 sectors for the week were Telecommunication services and Energy, which were up 4.31% and 4.23%, respectively. Shares of Verizon Communications (NYSE:VZ), a top constituent of the S&P 500 Telecommunication services sector, ran up 6.14% for the week after the company reported earnings that beat expectations. The S&P 500 Energy sector is traditionally traded along with WTI crude oil prices, which were on a roller coaster ride but managed to close up 4.62% for the week, at $33.74 on Friday, despite conflicting oil production information that emerged from Russia, Iran, Saudi Arabia and OPEC.

The worst performing sector for the week was Healthcare, down 1.86%. Shares of Express Scripts (NASDAQ:ESRX), a pharmacy benefit management company, sold off briefly on Monday, while the S&P 500 Healthcare plunged 1.02%, after Presidential candidate Hillary Clinton tweeted about prescription drug coverage, "There is no excuse for letting greed get in the way of people's health. Companies like these should be ashamed,". Mrs. Clinton may not have had all the facts before sending out her tweet as ESRX, and other pharmacy benefits managers, tell their insurees to take a lower-cost alternatives of expensive brand name drugs, and not the another way around. Hillary Clinton's tweet was very inconsistent with her plan for lowering prescription drug costs, which calls for more generics on the market.

Shares of Valeant Pharmaceuticals (VRX) went down 9.35%, and the S&P 500 biotechnology sector fell another 4.34% on Thursday, after Mrs. Clinton slammed Valeant during her stump speech in Iowa for raising their migraine drug prices. Here's what she said, "This is predatory pricing. It is unjustified. It is wrong," Valeant "is absolutely gouging American consumers and patients," Clinton told a cheering audience. "I'm going after them. We are going to stop this.", reported Bloomberg.

In response to her remarks, Valeant sent a letter telling Mrs. Clinton that the company sold just 200 units of the migraine drug in 2015 and was forced to raise prices to keep making it. The less-expensive generic versions of the drug sold over 40,000 last year and it's price has more than tripled since 2011, according to data compiled by Bloomberg Intelligence. It seems not to matter at this point, as the damage to the healthcare and biotech sectors has already been done.

S&P 500 Technical Chart

Technically, the descending broadening (DES/B) wedge chart pattern has emerged as the S&P 500 retested the technical support at 1814.36, or April 2014 low, last week and bounced off at 1,812.29 in heavy volume. The MACD line was at a 7-year low of -47.639 last week, signaling a possible bottom. The technical breakout level for the descending broadening wedge chart pattern is around 2,020. The S&P 500 could still be under selling pressure as long as crude oil prices are coupled with the index, and if oil can't break out of its lower-lows chart pattern, meaning WTI crude oil needs to close above $37.75 per barrel.

S&P 500 Summary: -5.07% YTD as of 01/29/16

Outperforming Sectors: Telecommunication services +5.48% YTD, Utilities +4.9% YTD, Consumer staples +0.45% YTD, Energy -3.07% YTD, and Information technology -4.9% YTD.

Underperforming Sectors: Consumer discretionary -5.19% YTD, Industrials -5.81% YTD, Healthcare -7.65% YTD, Financials -8.98% YTD, and Materials -10.62 YTD.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.