Yesterday, US CPI came in stronger than expected, coming in at 2.6% year-over-year. We think this move is unambiguously reflationary. We see this inflation was already priced-in recently in the bond market:

Hence, we think of the current CPI print to confirm our views mentioned before the print. To reiterate, we are likely in a rising inflation environment:

This CPI print also puts the US in the lead in terms of global reflation, with the highest inflation rate amongst the major currencies:

This is just confirmation of what asset markets have been telling us. We are still in a global reflation, led by the US economy. However, signs are emerging that we are at peak reflationary impulse, and we need to be vigilant.

Tomorrow, we get US CPI, which is likely headed into strong territory based on our cyclical model. Our cyclical model does a good job of getting the medium-term trend right more than the exact print:

Indeed, this expectation is in line with what a range of market-based indicators is pointing to:

We see further evidence of this from the recent acceleration in ISM prices paid, which gives us an indication of the coming CPI print:

Overall, we are likely in an accelerating inflation environment, a move which we think is priced in across many markets. A strong CPI print will just confirm the reflation story. However, as we’ve written about recently, we need to start thinking more about fading reflation trades. Our preferred gauge of US reflation- the US stock market- remains elevated relative to our trading ranges:

At this junction, either our trading range will shift upwards to accommodate recent strength, or the S&P will correct. We’re definitely waiting and watching to see how this evolves. Markets are at an important junction.

Increasingly, we find ourselves thinking about the limits of the reflation trade. Admittedly, our research team has been aggressively bullish on global reflation, especially beginning 2021. However, we think it is time to start orienting towards a regime shift. Now, this doesn’t mean that we abandon our reflation positioning across investments. Rather, it means we start looking for the tell-tale signs of a regime change from reflation to a moderate expansion. We think the context below is important, particularly for EURUSD, JPYUSD, and DXY:

Above, we show our model-driven estimates of future Industrial Production for the UK, US, and Japan. We use industrial production to measure global business activity, and our models are pointing to peaking YoY numbers in June-July of 2021. Markets are forward-looking, and as we would expect, they have already priced in the numbers, which can be seen in our global risk appetite measures (defined as total equity allocation):

As we can see above, our risk appetite measures have started to come down after posting record-highs earlier this year. We think this is largely a function of markets beginning to price the next phase of the global economic recovery, i.e., one where growth will continue, but its pace will likely decelerate. This is consistent with the currently elevated levels of global growth expectations, making it hard for growth expectations to increase further:

As we can see, the consensus forecast shown above is already pricing in a high rate of recovery for major economies. Hence, we see little room for these to continue to climb substantially. As such, we need to start monitoring the situation carefully to assess when we are definitively in regime change. Particularly, we think that the best information to gauge reflation narratives is embedded in major economies’ equity markets. We will be watching price action, implied earnings growth, asset allocation, and momentum carefully. For the time being, reflation looks like it continues. However, we need to start looking for the next regime shift.

Gold has gone through considerable pain this year- down almost 9% year-to-date. After being aggressively bullish gold for the majority of last year, we pivoted to bearish this year. Our rationale, while multi-factorial, can be boiled down to us expecting risk assets to rally as reflation continued. This move indeed played out as we expected, and gold is now down significantly from its all-time highs from last year. The question we find we’re asking ourselves today is how long this environment can continue? To answer this question, we offer our cyclical model for gold, a reliable signal for future gold trends over a long time. While gold will eventually turn upwards, there looks to be some downside left:

As we can see, our cyclical model has indeed been a strong predictor of gold trends, and we don’t expect this to continue. According to our estimates, gold will likely continue to fall as long as the US equity market continues to rally. We think that focusing on this fact, rather than a specific date as a turning point, is a superior approach. To get a better sense of market timing, we look at gold through our risk measures:

Recall:

• Trading Range: These ranges represent a trading bank within which a currency should trade based on multiple market factors. If we are long- prices above the upside range indicate the asset is expensive, and prices below the downside range suggest that they are cheap and vice versa if we are short.
• Year-to-Date Returns: This is the price performance of a given currency over the course of the current calendar year, in percentage terms. We also compare the current price to the 52-week high and low for reference.
• Price Momentum: This looks at cumulative rolling returns for a selected lookback period.  Positive momentum is good if we are long and bad if we are short. 
• Implied Volatility Discount/Premium: This tells us what the market expects in terms of volatility relative to the history of volatility. If we are long a currency, we typically want market implied volatility to be higher than historical volatility and vice versa if we are short.

Longer-term indicators are pointing to lower gold. Further, the recent spike in gold prices has compressed volatility to a level that looks inconsistent with recent history. However, we do need to be careful as price momentum over the last momentum has turned positive. Overall, there seems to be further downside left until the reflation narrative tops out.

One of the few things that EURUSD typically has going for it to the upside is the strong deflationary forces that pervade its economy. However, today’s HICP inflation print for the Eurozone tells us otherwise. Below, we show US and EUR inflation rates, respectively:

As we can see, the most recent print puts EUR HICP quite close to USD CPI, making its real rate of return even more unattractive. Of course, these inflationary pressures could be transitory, but they are not additive to EURUSD strength for the time being. Since the start of 2021, we have been bearish on EURUSD based on our fundamental outlook that the US would outperform Europe, resulting in inflows to the dollar. Our execution of this view has been augmented by our trading ranges, which we show updated for EURUSD below:

As a reminder:

• Trading Range: These ranges represent a trading bank within which a currency should trade based on multiple market factors. If we are long- prices above the upside range indicate the asset is expensive, and prices below the downside range suggest that they are cheap and vice versa if we are short.
• Year-to-Date Returns: This is the price performance of a given currency over the course of the current calendar year, in percentage terms. We also compare the current price to the 52-week high and low for reference.
• Price Momentum: This looks at cumulative rolling returns for a selected lookback period.  Positive momentum is good if we are long and bad if we are short. 
• Implied Volatility Discount/Premium: This tells us what the market expects in terms of volatility relative to the history of volatility. If we are long a currency, we typically want market implied volatility to be higher than historical volatility and vice versa if we are short.

Our current read of these technical tools tells us that EURUSD is still attractive to short. Implied volatility continues to paint a picture of complacency, and momentum is definitely in favor of more downside. As the market begins to look past weak European data, EURUSD can bounce. However, our judgment is we are not at that point yet. US data’s relative outperformance has likely only just begun, so there are likely legs left for EURUSD to slide.

Today, we received updated consumer confidence data in the US. The data was extremely strong relative to consensus expectations (109.7 vs. 96.9). This data came after we also received the best initial claims data since the start of the pandemic. All of the indicators bode well for future spending:

This is being reflected in equity markets, which remain at all-time highs. However, from a trading perspective, the S&P 500 does not look like a buy right now, as it is in the middle of our trading range (equal upside and downside):

Momentum in the S&P 500 still remains broadly positive. However, markets are discounting less volatility than is justified by historical volatility, suggesting there is a possibility for a pullback. This pullback should provide a good entry-level for long positions.

There is a narrative in markets that the US dollar is on its way to losing its place as the world’s reserve currency. This view has been supported by a dramatic decline in the dollar last year relative to virtually every currency and asset. However, beginning this year- we at FXDD were among the few strategists warning our readers that this dollar decline couldn’t continue (in trade-weighted dollar terms). This view has played out well so far, particularly in EURUSD. Below, we show one of the primary reasons this has held up:

Above, we show consensus estimates for GDP growth for major economies. What we can see above is that the US is expected to grow the most consistently in 2021. This expected economic growth is fueling expected returns on assets relative to other countries. We can see this in our measure of US asset average expected returns, a measure which coincides strongly with the dollar index:

As the US economy continues to outperform other economies, the dollar will rally. This will be particularly against currencies of countries that underperform relative to the US. At this junction, it’s important to remember that there are strong reasons why the dollar is the world’s reserve currency- it is supported by a dynamic and profitable economy with deep financial markets. When choosing short dollar expressions, we need to be careful in choosing countries that can outperform the US, a fairly high bar.

Today we received updated data on UK PMI’s and CPI. While CPI was a little disappointing, PMI data was strong relative to expectations. This growth recovery is supportive of GBPUSD:

However, we have to remember that GBPUSD is the product of both the US and UK legs of the currency pair. PMIs are survey data that give us an insight into the underlying real economic data, i.e., manufacturing PMI’s give us insight into how industrial production will look. Looking at the US vs. UK industrial production, we see that their rates of recovery are neck-and-neck:

Further, as we alluded to last week on this page- the criteria for positioning in GBPUSD has not been triggered for all our signals. We show our updated panel of trading indicators for GBPUSD. They include:

• Trading Range: These ranges represent a trading bank within which a currency should trade based on multiple market factors. If we are long- prices above the upside range indicate the asset is expensive, and prices below the downside range suggest that they are cheap and vice versa if we are short.
• Year-to-Date Returns: This is the price performance of a given currency over the course of the current calendar year, in percentage terms. We also compare the current price to the 52-week high and low for reference.
• Price Momentum: This looks at cumulative rolling returns for a selected lookback period.  Positive momentum is good if we are long and bad if we are short. 
• Implied Volatility Discount/Premium: This tells us what the market expects in terms of volatility relative to the history of volatility. If we are long a currency, we typically want market implied volatility to be higher than historical volatility and vice versa if we are short.
  
  As we can see, GBPUSD remains at the high end of the trading range, with 1-month momentum signaling more downside as well. Overall, while the UK’s outlook is improving significantly, its scope to outperform the US in the rate of change terms is diminishing.

While we often take a fundamental approach to understand direction, we just as often take a quantitative approach to assess trade positioning. Particularly, a big part of our risk process is establishing where the prevailing trend is and then understanding its sustainability. Below, we show some of the measures we look at to understand momentum in currencies and select commodities:

We see above that popular short-dollar expressions from last year continue to see strong momentum to the downside, particularly for Euro, Yen, and Gold. This is coming when US real interest rates are picking up, offering a significant yield advantage over these assets. Hence, it makes sense that these continue to experience negative momentum. We show our momentum indicator for each of these below. We first show gold:

Gold is currently experiencing a counter-trend bounce. However, it will take a lot of price action to change the underlying trend ad we can see above. That being said, with downside momentum this extended, it is possible to see a moderation in the pace of declines in gold.

Next, we look at EURUSD:

After a stellar 2020, EURUSD remains a strong downside call for us in 2021. US relative outperformance will likely push the Euro lower- but with momentum this stretched, we might see a breather.

Finally, we look at the USDJPY (inverted):

The Yen has seen significant weakness as this safe-haven currency has experienced both outflows and debasement by its central bank actions. Momentum to the downside has been significant over the last few months.

Overall, these expressions of dollar alternatives have seen significant losses as US yields have risen. A US recovery increases the attractiveness of US assets relative to these alternatives. We’re likely only seeing the start of these moves- though, from a momentum perspective, it is worth noting that these moves all look extended.

The most dominant theme in the market right now continues to be the reflation theme okaying out in US markets. Cyclical assets are outperforming safe/stable assets, and we see this across asset classes. The best case in point is in the US Treasury market, with US long-term bond yield selling off considerably. These moves are largely due to the US economy’s cyclical outperformance, a move which is expressing itself in EURUSD. EURUSD is exposed to this narrative as Europe is struggling to grow out of the COVID-19 crisis. Hence, the relative attractiveness of US assets weighing down EURUSD. We show this here:

From a trading perspective, our risk range is pointing to an attractive entry point on EURUSD given the recent bounce:

After periods when a currency pair hits/exceeds our upside or downside ranges, we typically see a correction. While we don’t think trading just for that move is the best idea, the current environment seems to favor a weaker EURUSD.