Welcome back to On the Daily, FXDD Research’s blog, where we break down and contextualize market and economic data through our research process. Recently, we espoused a “portfolio pivot” to clients, where we became substantially more bullish on US stocks relative to commodities. Last week, this move paid off handsomely, with the S&P 500 posting a 3.45% gain in one week. However, this morning, equities look a little shaky (thus far) after weaker than expected housing data. The overall sentiment in the market remains one of a deflationary bent:

As we can see above, markets have generally implied a slowdown in global growth and inflation over the last month. However, combining our various signals above, we can see that the market odds of growth rising are still strong. However, this outcome is fairly limited in geography, with US markets predominantly reflecting this environment via strong stock market performance whilst other regions lag behind.  This week will be important in determining the future of US outperformance- we receive durable goods orders data in the US (an important leading indicator), and more importantly, we will have the FOMC meeting. Going into the meeting, the last month has largely been a strong dollar environment, as evidenced below:

The confluence of a strong dollar and gold performance solidifies the idea that the wave of global risk-on and the easy “buy everything” trades are largely at an end. We see further evidence of this in our Currency Bloc Monitor, which aggregates currency movements across 42 global currencies into currency regions or “blocs” to help us understand the trend in global capital flows:

As we can see above, every Currency Bloc ceded flows to the dollar. The question before us this week is whether or not Jerome Powell and the FOMC will reinforce these moves or temper them. Earlier this year, we wrote about how our estimated target for taper initiation would be in December, based on our projections for the labor market. We continue to think this view holds- however, we do have questions about the communication window of this taper. While we know that Powell has assured markets that the Fed will communicate the taper “well in advance” of initiation, we aren’t sure how to define it- does it mean three meetings ahead, or four? Assuming the Fed decides to move in December, our best judgment would be that the FOMC communicate the change in September. Therefore, we don’t think that the Fed will shock the world this upcoming meeting, but we do think they could begin to line up taper communication. In this context, the price performance of our preferred US exposure- i.e., US equities, will largely depend on how this lineup is communicated. We stay bullish into the meeting but wouldn’t try to add aggressively ahead of the meeting, but rather ride a potentially dovish meeting. For best execution, we show our trading ranges for US stocks below, which concur with this diagnosis, showing implied-volatility discounts, i.e., incrementally less bullish signs than last week.

As a refresher on our lenses:

  • 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 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 a reminder- it is not just enough to have the technical tools we provide here. You need to know the fundamental developments in markets that are driving these moves! Head to https://www.fxdd.com/mt/en to get access to our research and analysis.