April 12

Stocks & Euro Stuck in a Range

The S&P 500 has remained stuck between 2020 and 2060 for almost a month now. Price first crossed into this zone in mid-March just after Janet Yellen walked back her guidance on interest rate hikes. The rebound in stocks has been fueled by a recovery in commodity prices and a weaker Dollar. The Greenback has fallen broadly, with the Yen leading the way higher in what looks like a break of its usual correlation with equities. Commodity and Emerging Market currencies have rallied in recent days with USDZAR dropping back down near 2016 lows at 14.60 and USDTRY seeing steady lower highs. A strange part of recent FX price action has been the extremely tight range in EURUSD. The pair has been between 1.1380 and 1.1450 for almost two weeks now.

Stocks and the heavily Euro weighted Dollar Index are somewhat correlated as risk and the Buck have traded together in recent months, but the Yen has bucked this trend for unknown reasons. What we do know is that even as stock markets have rebounded off the lows and sentiment indicators and inflation improve, the Dollar has not been able to benefit. Janet Yellen’s re-calibration of forward guidance last month has scared off most Dollar longs with positioning at the lowest levels since mid 2014.

At the moment asset correlations are in a stage of flux. Markets are digesting the big move lower in global bond yields and an apparent central banker agreement at the February G20 to suppress volatility. At the moment it is hard to know whether a weaker Dollar will boost stocks, or if stocks declining may eventually push the Dollar lower. In the midst of this the Dollar Index to equity correlation has been breaking down as the Yen has surged 5.5% in the last month, even though the S&P 500 has gone sideways.

One or both of these ranges will break at some point, with catalysts likely to be US economic data. Retail sales is out this week on Wednesday, with CPI coming out Thursday.  The inflation data could be the main point of contention. The last core CPI print came out at 2.3%, so markets are on the lookout for price pressures that could at the very least reduce the Fed’s carefree attitude about interest rate policy. It is worth pointing out that many traders expected the FOMC to be hawkish at the March 16th meeting as labor market data and inflation numbers show that the Fed has essentially met mandated targets. The continuous moving of the goalposts is starting to put the Federal Reserve’s credibility at risk, as investors are starting to suspect the Fed is market dependent and no longer data dependent.

Inflation pressures could also be buoyed by oil’s 40% rally off the lows and a weaker Dollar. These moves will need to consolidate for a couple of months for the gains to show up in monthly CPI, and yet even longer to appear in the year over year data. In the near term, the Fed can continue on its current trajectory of intentionally positioning itself behind the curve. The recent ranges may continue for the time being and there may be a final push into high yield and EM carry trades, but the longer Yellen plays this game the greater the eventual opportunities will be toward the end of the year as the FOMC either plays catch up or lets inflation run significantly higher than target.

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