Bracing for the next big swing

Markets

In the unfolding drama of the financial markets, our bull market, against all odds, remains resilient amidst a tempest of volatility. Imagine a scenario straight out of a thriller, perhaps akin to the 1987 Black Monday, where a growth scare converges dramatically with a herd of crowded trades stampeding for the exits simultaneously. The market was engulfed in a whirlwind of forced deleveraging, creating scenes reminiscent of a Wall Street horror movie.

Thankfully, the unwind was swift. Had it dragged on, the Fed would have been compelled to intervene heroically to avert a systemic collapse. Credit markets, resilient as ever, snapped back quickly. However, without a shift in Fed policy in September to ease and cushion the economy, not to mention prop up stocks,  last week's turmoil might only be a dress rehearsal of the chaos that could erupt in the S&P 500, especially if the recession signal starts waving an abrupt U-turn flag on the road ahead.

Reflecting on last week’s frenzied events, I'm struck by the thought that Jay Powell's anticipated appearance in Jackson Hole, followed by the FOMC meeting, could be more consequential than typical. Clearly, the events will not be another bland Fed update.

This week, we're served a hefty economic platter as we shift focus from the labour market's recent upheavals to the critical role of inflation. July’s CPI, PPI report, and retail sales data are on the menu. Any unexpected spikes could complicate the already loud calls for a significant 50-basis point cut at the September FOMC meeting.

Meanwhile, a cocktail of potential market disruptors is brewing. We're eyeing a sputtering U.S. economy, the Middle East simmering on the brink of chaos, and sky-high equity valuations, least of all the US election drama—all ingredients for potential upheaval. Any of these elements could be the spark that ignites another round of market fireworks.

Prepare for a week packed with crucial data and key geopolitical developments. It promises to be a thrilling chapter in the global financial saga, ensuring traders and analysts are glued to their screens, riding the rollercoaster of market sentiment. Just like seasoned surfers watching the horizon for the perfect wave, market participants are bracing for the next big swing.

Forex 

As they often do, Bank FX Traders will figure this out fast; the last thing they want is to be late off the blocks on this trade.

The USDJPY is still the key nexus. 

Sure, the Bank of Japan is now hesitantly turning into the market's reluctant rate hiker, with the street pricing a 30% chance of an 8bp hike in December( down from 60% one week ago)—odds I'm selling as my analysis immediately post Tokyo meltdown pegged them closer to zero.

And yes, economists are coalescing around a 25 bp hike from the Federal Reserve in December, and there is a 50:50 chance this week’s US inflation and retail sales data will walk back current market dovish pricing.

Of course, BoJ's Deputy Governor has eased fears of an accelerated unwinding of the “at-risk” short JPY carry trades.

Still, with global risks still on the boil, I can hardly envision USDJPY pushing past 148.35, let alone revisiting 150 in the current climate.

Sure, some traders are expecting core CPI to cling stubbornly, especially on the services side. But the labour market is tossing its own curveballs, nudging the needle towards stagflation as unemployment ticks up—a scenario that could turn the heat up in the economic kitchen. 

Switching gears back to the yen, let's talk about the market's pulse—regression models from big hitters like UBS, Goldman Sachs, and MUFG singing a similar tune. They've crunched the numbers and suggest the yen's recent weakness was a bit overplayed. Though USD/JPY has shed some of its unwarranted strength, there’s chatter about more room to fall if the Fed aggressively plays the rate cut card. Adding a twist to the plot, there's a rising star: potential yen repatriation flows fueled by the earthquake back in Japan.

Blending these dynamics, unless the forthcoming US CPI report throws us a significantly “high-and-away” curveball with unexpected twists, tossing base effects out, it’s poised to underscore a cooling of inflation pressures. With the labour market loosening up, I'm betting on subdued wage hikes to dampen any fireworks from domestic demand, pointing to a downward trajectory for USD/JPY.

And here’s a side bet—there’s a tasty opportunity to go long on EUR/USD as we roll into the CPI reveal. I’m banking on the euro to at least hold its ground, if not serenade us past the 1.1000 mark on the sweet notes of muted inflation. Those are the odds I’m ready to dance with!

Lags

And let's talk about the long and variable lags in monetary policy—it's supposed to work magic over time, but does it really? After three decades in the market trenches, I'm baffled by how stubbornly ineffective high rates have been at cooling things down this time around. It's like watching a slow-motion train wreck for the average Joe. You'd think a rate cut might turn things around, but I'm not holding my breath. With grocery "greedflation" stubbornly high and real rates still oppressive, consumers are getting squeezed dry. It leaves us all scratching our heads, wondering if the Fed's next move could even help.  I'm not talking about the fantasy world of Wall Street where stocks will go up with a 50 basis point cut. I'm talking about the average person on Main Street who makes $60,000 per year and couldn't care less about where the S&P is headed. They are more worried about meeting their mortgage payments, especially since they are now paying an additional $24,000 per year to support their family. How do folks make ends meet?