Dow, UK FTSE set to join Australia’s ASX in the bullish breakout club?

• Developed central banks are starting to cut interest rates
• For now, the odds of a soft landing for the global economy appear to be growing
• Cyclicals should benefit in such an environment, such as Australia’s ASX 200 which staged a bullish breakout on Wednesday
• Dow, UK FTSE futures are coiling within triangle patterns
• US inflation report, earnings season provide macro risks

The monetary tide is turning globally

Interest rates are being cut across the developed world. What started in Switzerland has shifted to Canada and Euro area. Even some of the most hawkish holdouts are starting to turn, as witnessed with the Reserve Bank of New Zealand’s dovish pivot this week. Should we get more “good news” on the inflation front in the United States on Thursday, the Federal Reserve could well be next to join the global easing club.

As seen in this chart from Bank of America, the monetary cycle is undeniably turning with no central bank worldwide hiking rates in June. Not seen since October 2020 has that been seen.

Source: Bank of America

The focus is shifting from curbing inflation to supporting economic growth. And, unlike synchronized easing cycles of the recent past, this one is not taking place under a backdrop of turmoil. That could still play out – monetary policy works with long lags – but it looks like we may be on track for a soft landing globally.

This should benefit cyclicals if growth holds up

The combination of lower interest rates and positive economic growth should benefit cyclical assets, including cyclical stock indices which have lagged during the aggressive rate tightening cycle of recent years.

Coming just a day out from the key US June inflation report, one of the most cyclical stock indices globally, Australia’s ASX 200, surged overnight, breaking out of the triangle pattern it had been trading in since the latter parts of May. If convention holds, it may take out the record highs struck earlier this year.

The breakout piqued my interest in what’s going on in other cyclical stock indices around the world, such as the Dow Jones Industrial Average and UK FTSE. Coincidentally, they too have been coiling up in triangles over the same period. Only difference is they haven’t broken out.

Dow bullish breakout on the menu?

Dow E-mini futures look like they may follow suit, briefly breaking above triangle resistance on Wednesday before closing right on it. It’s only early days, but with Asian markets set to sizzle on Thursday following the big rally on Wall Street overnight, there’s a chance we may see a bullish breakout take place over the next few hours.

If it does occur, traders could buy around these levels with a stop loss just below the downtrend for protection. Seller may be found near 40200 but you’d imagine bulls will want to have a crack at the record highs of 40358 if we see a breakout. Considering where the triangle pattern formed, a push into the low 40000s could be cards should the record high be taken out.

For the moment, price momentum is with the bulls.

UK FTSE 100 futures coiling up for a break

In contrast to Dow E-minis, UK FTSE 100 futures are trading near the bottom of the triangle, bouncing off support in each of the past two sessions. If we see another test and bounce from the bottom of the range, traders could initiate longs with a stop below Tuesday’s low of 8157 for protection. The initial trade target would be the top of the triangle/50-day moving average around 8280. Above, 8351.5 and the record high of 8489 are levels to watch.

For those considering buying at these levels, you’d want to place a tight stop given the setup is nowhere near as appealing sitting in the middle of the existing range.  

Momentum is not providing a definitive signal on directional risks at this stage, although RSI is inching higher which hints downside risks may be ebbing.

Managing macro risks

While the macroeconomic backdrop looks favourable for cyclicals, you can’t escape that we have some big risk events to navigate that could deliver bull traps and/or reversals.

I’ve written plenty about Thursday’s US inflation report already, but a core reading above 0.25% later Thursday would likely act as a hammer blow for bullish cyclical trades, likely delaying the start of the Fed’s easing cycle. Conversely, if we were to receive a soft outcome below 0.2% that continues the disinflationary trend of the prior two months, risk could rip as odds strengthen for a September Fed cut.

Earnings season is another hurdle, although we know that analyst expectations and company guidance tend to be ultra conservative by design. Ignoring the beat rate, it really comes down to guidance. If it holds up or is bolstered by the prospects of the next easing cycle, equities should hold up, especially as the AI hype has arguably not entirely permeated down to other sectors outside of tech and communications.

According to Factset, S&P 500 aggregate earnings are expected to increase 8.8% in Q2 relative to the same period a year ago. A large bulk of the increase is accounted for by long duration sectors such as tech, healthcare and communications. That’s where the risk of disappointment is concentrated, rather than cyclicals that have a degree of pessimism factored in. 

Source: Facset

-- Written by David Scutt

Follow David on Twitter @scutty