Week of Aug 25 2024

Of note has been the atypical behavior of the US dollar. Contrary to its traditional role as a safe haven during risk-off periods, the dollar has shown persistent weakness, selling off both during the recent risk-off phase and the subsequent risk-on relief rally. This trend, initially driven by a sharp yen rally and later by strength in other major currencies, aligns with the changing global macro theme and often precedes Fed rate cutting cycles. Chair Powell's recent comments reinforcing expectations for rate cuts and highlighting the Fed's "ample room" for action have further solidified this dollar weakness. As a result, the British pound has reached new two-year highs and the euro is at its highest level since July last year. In the fixed income landscape, Federal Reserve Chair Powell's dovish speech at Jackson Hole has firmed up expectations for rate cuts, leading to declining Treasury yields across the curve. This has resulted in stretched long positions among trend-following CTAs in US Treasuries, with the 10-year Treasury futures long at its highest level since August 2021. The divergence between bullish equity signals and potential challenges for bonds, as indicated by the Copper/Gold ratio, underscores the complexity of the current market dynamics. In the currency markets, the US dollar's five consecutive weeks of decline, with CTAs buying EUR and JPY, coupled with the potential for significant long AUD positions, suggests a shifting landscape in FX that could have broader implications for global asset allocation. Meanwhile, commodities present a mixed picture: gold sentiment is unusually high compared to other major assets, while oil and copper are seeing potential unwinding of short positions among CTAs.

The left tail risk in this environment stems from the possibility of a rapid unwind of stretched long positions in US Treasuries if yields suddenly spike, potentially triggering volatility across asset classes. There's also a risk that markets may have gotten ahead of themselves in pricing in rate cuts, which could lead to disappointment if the Fed moves more slowly than expected. The unusual dollar weakness, if suddenly reversed, could also disrupt current market dynamics. Conversely, the right tail risk lies in the potential for accelerated equity buying if CTA trends strengthen, combined with continued strong corporate earnings growth and a "Goldilocks" economic scenario that allows for both low inflation and sustained growth.

From a technical perspective, key thresholds to watch include the S&P 500's movement relative to its 50-day and 200-day moving averages, sector-specific metrics like the 10-day Advance/Decline ratio for Financials, and the evolution of gamma positioning in the options market. The current moderate long gamma position of $6.8 billion in S&P 500 options suggests potential for increased stability, with the possibility of amplified upside moves in a strong rally. Additionally, currency levels, particularly in GBP/USD and EUR/USD, will be important to monitor given their recent breakouts.

Looking ahead, key catalysts include a series of important economic data releases. The market will be closely watching the Chicago PMI, consumer confidence, and personal income and spending data (including the PCE deflator) in the US, as well as inflation data from Europe and the German IFO. These indicators will be crucial in shaping expectations for future Fed policy and assessing the global economic landscape. Additionally, Nvidia's earnings and Chinese bank results will be significant focal points for investors, potentially influencing sentiment in the technology and global banking sectors respectively.