“It’s all a US dollar trade,” Nomura’s Charlie McElligott said Monday, while recapping the trio of macro drivers which combined to trigger a dramatic turnaround in the previously unstoppable greenback, but which are now all reversing, and threatening risk assets in the process.
The cooler-than-expected October CPI print in the US, optimism around the avoidance of a worst-case energy crisis scenario in Europe and speculation on a gradual end to “COVID zero” in China, together delivered a veritable brake-slam for the dollar, which experienced its largest six-day drawdown since the volatility around the financial crisis (figure below).
In recent days, Fed speakers have pushed back against the notion that a single CPI print is cause for ebullience, markets remembered that Europe remains in dire straits and the Chinese reopening meme quickly received a reality check, as cases soared and Beijing reported three deaths in two days.
“China’s again-devolving COVID outbreak, the ultimate arrival of cold European weather and a raft of better US economic data late last week is flowing through to financial markets via a suddenly-squeezing US Dollar,” McElligott remarked.
This comes as specs moved net short for the first time in more than a year, while asset managers are the most net short in 16 months (figures below).
It might’ve been tempting to suggest that the dollar reversal so poignantly illustrated above was mostly the result of stop outs in crowded dollar longs, but that’s a bit of a chicken-egg dilemma. There was a catalyst. Three of them, in fact.
“Up until [the CPI print] legacy ‘FCI tightening’ trade expressions most clearly represented by ‘Long USD’ had worked all year and were, accordingly, very crowded [but] the dollar’s recent blast weaker wasn’t simply about crowded [long] expressions being taken down,” Charlie said. “The fundamental macro drivers were inflecting simultaneously… so now to get even the smallest incremental change to those three catalysts, but against cleaner positioning and even greater year-end illiquidity, is going to have an impact, especially following US data re-acceleration and hawkish Fed talk.”
Plainly, this won’t be the best week for “clean reads” (so to speak) given the holiday, but the overarching point is that dollar weakness was a big part of the recent easing in financial conditions and accompanying relief for assets of all sorts. That dollar weakness was predicated on three macro drivers, all of which are now in question.
BofA’s Michael Hartnett recently suggested that a boisterous November jobs report could be the death knell for the latest bear market rally in equities. That’d be consistent with the notion that notwithstanding “peak inflation,” there’s scant support in the data for any meaningful Fed deescalation. If the situation in Europe and China deteriorates against a Fed that still has ample hawkish air cover from strong labor market data, the dollar would be supported by firm terminal rate pricing, all else equal.
According to a quant model often cited by McElligott, “USD liquidity” as proxied by cross-currency bases, shows a weak dollar was the most important driver for US equities. That, he wrote, means a stronger dollar “has the opposite effect.”
