Week of May 18 2025

Competing views on dollar trajectory reflect broader market tensions, with Deutsche Bank predicting necessary dollar weakness due to America's external position, while DataTrek notes May's dollar strengthening amid tech sector inflows. These conflicting signals extend globally, as Japan's Q1 GDP contracted -0.7% and manufacturing weakness persists across regions, though Yardeni Research maintains the economy shows resilience rather than stagflation, particularly in consumer spending, even as markets digest the temporary US-China tariff reduction agreement.

Market technicals have been dominated by extraordinary positioning and mechanical flows, including one of the largest short-covering episodes by hedge funds in five years (Z-scores exceeding 4 standard deviations) and Friday's massive options expiration creating a "precarious equilibrium." The critical "Delta Flip Threshold" at 5950 for the S&P 500 remained key, with potential for dealer hedging dynamics to accelerate movement toward 6000 given significant gamma exposure at key strikes. These mechanical factors have temporarily overwhelmed fundamental concerns, potentially masking the market's true reaction to conflicting economic signals. As these flows normalize post-options expiration, market participants await clearer signals on which competing narrative will dominate asset allocation decisions in the weeks ahead.

Left-tail risks include concerns of accelerating economic contraction, policy error if the Fed doesn't cut rates soon enough, deflationary spiral, and fiscal unsustainability. Right-tail risks involve unanchored inflation expectations becoming permanent, policy-induced inflation surge, and technically-driven market momentum overwhelming fundamentals. While the US-China tariff truce reduced immediate trade risks, consumer surveys indicate policy uncertainty remains elevated.

Key Week 21 catalysts include Thursday's flash PMIs across major economies and eleven scheduled Fed speaker appearances. Markets seek clarity on whether policymakers prioritize deflationary signals or unanchored inflation expectations. Chinese activity data, ECB minutes, and US jobless claims will provide further context on growth and policy direction.