×

Tuesday Look Ahead: Easing Trade Fades, Risk Correlation Shows Signs of Unwinding

Some of the tight market correlations, where asset classes move in tandem, are showing signs of cracking.

NYSE_building_200.jpg
Paul Giamou | Aurora | Getty Images

Monday's market action saw bonds sell off, the dollar gain, and stocks and commodities finish mixed. That may be more like the type of trading that lies ahead, some strategists say.

Markets had been trading in a "risk on" pattern, especially apparent since the Fed started talking about quantitative easing in late August. That trade resulted in a weaker dollar and higher stocks and commodities prices. Bonds also rose in anticipation of Fed purchases of Treasury securities.

Tuesday's markets will be focused on the European finance ministers meeting in Brussels, where the debt crisis and the proposed bailout of Ireland are expected to be discussed.

Traders are also watching earnings news from Wal-Mart, Home Depot,Saks,TJXand Abercrombie and Fitch after Monday's better-than-expected October retail sales report. Data includes PPI inflation data at 8:30 a.m., Treasury international capital flow data at 9 a.m., and industrial production and capacity utilization at 9:15 a.m.

Whither Markets

Oppenheimer chief market technician Carter Worth says the "hyper correlation" of financial markets may be over for now. "To go from here, you really have to be standing on your own two feet," said Worth.

He now expects Treasurys to go "meaningfully lower." Stocks may also be at a point where they start to back and fill on gains. "You back and fill, or you back away," he said. Either way, he does not see stocks continuing to rise, at least through the end of the year.

Brown Brothers Harriman's chief currency strategist Marc Chandler found similar potential for a break in the trend. While it's still too early to see a pattern in five or six sessions, he said there is an unmistakable move between the dollar and euro and risk assets.

"For the better part of the last couple of years, the euro has correlated with the stock market. We might be seeing that break down," he said.

"Ultimately, it's a spurious correlation. There's another day that the dollar is getting stronger, not because of rising U.S. stocks, but probably because of rising U.S. yields," he said.

Yields have risen in recent days as U.S. data, for the most part, has been slightly better than economists expected. The euro has also moved lower on worries about Europe's weaker economies, as Ireland's unwieldy debt burden has resulted in talk of a bailout.

The dollargained nearly a percent against the euro Monday to its highest level since Sept. 27. The euro fell to $1.3569, its fifth loss in seven sessions. The dollar also rose 0.9 percent against the yen.

"Rising U.S. stocks and a rising dollar could go together," Chandler said.

The Dow Monday was up 9, to 11,201, well below its intraday high of 11,280. TheS&P 500, meanwhile, slid 1 point to 1197, and theNasdaq was down 4 at 2513.

Fed Under Fire

Last week, the Fed's quantitative easing program came under attack from G-20 members while President Obama was attending their summit in Korea.

This week, the Fed is coming under fire from Republican lawmakers and a group of economists who want Fed Chairman Ben Bernanke to drop the program. The Fed plans to buy $600 billion in Treasurys, in an effort to drive rates down and reflate assets.

But since the Fed announced its plan to ease in early November, rates have been rising as bond prices fall. Treasurys Monday were again under selling pressure, and the 10-year yield, as a result, rose to 2.911 percent, the highest level since Aug. 5.

"Everybody and their mother was short the dollar," said CRT Capital chief Treasury strategist David Ader. "I think these are unwinds of active positions.

Ader said the quantitative easing tradee to buy Treasurys intensified in October, as dealers faced year end and the Fed's November meeting. The yields on Treasurys fell in those weeks, and the 10-year was yielding a low 2.33 percent on Oct. 5. "It was a no brainer trade," he said.

"What I do know is it's November 15, and people had a very good year in stocks heretofore. What you do now is book your profits. I guess some of the motivation for trading at this point of the year has something to do with the calendar and with those sort of trades, we may come across this sense of decoupling, only to recouple when things are easier," he said.

Ader said the fury around QE is unlikely to change anything. "It's 9.6 percent unemployment, and 0.8 percent year over year CPI. That is what the Fed is worried about, and the Fed has a job," he said.

"I still think that 10-year yields go to 2.25 or below. I'm not seeing the data shift enough, and I'm not dismissing the Fed's ability to buy a lot of securities," Ader said.

- Follow me on Twitter @pattidomm.

Questions? Comments? Email us at marketinsider@cnbc.com