US economic markets could be in for a surprise soon. There is this little-tracked phenomenon that is providing a warning sign around US economic risk appetite. The reason it has been ignored is that for so long there hasn’t been anything to report. As usual, it’s the more volatile stock market that could provide the first indications for what’s coming in forex.
The thing is, it’s been a year since the last time the S&P 500 fell by more than 2%. Why that matters isn’t immediately obvious, particularly for forex traders. The thing is, volatility – ups and, importantly, downs – are inherent to the stock market. And the risk-safe harbor relationship means that the bigger swings in the stock market are mirrored in the currencies market. And we haven’t had a big negative swing in stocks that would be reflected in forex for a while.
Why it Matters
The market routinely “corrects” itself to make sure it’s not over bought. But the stock market has been on a tear for a year now, and that has pushed valuations to the highest they’ve been since the pandemic. The last time they were this high without a pandemic? The Great Financial Crisis. Before that? That would be the dot-com bust. And before that? Nothing. This is only the third time in history that valuations have reached this level.
In order for the market to return to a more “normal” valuation profile, it would have to have some kind of correction. That would likely be felt in the currency market, as the drop in stock prices would send people scurrying into treasuries, pushing up yields. The result would be a stronger dollar, weakness in commodity currencies, and the USDJPY potentially popping back above 150.
What’s Going On
The phenomenon can be seen in the latest US economic CPI results. Headline inflation rate rose, and the core rate stagnated in its descent. This means that the fight against inflation is far from over. But the bond market didn’t move. Futures say traders are betting on the Fed cutting rates in June, and the new data didn’t change their minds.
The Fed has repeatedly tried to warn the market that it won’t be cutting rates soon, with the latest jolt being after the last FOMC meeting. We’re in the blackout period ahead of next week’s Fed meeting, and the result is likely to be the same. The upcoming data, such as PPI and retail sales are not as important as the recent CPI, so are unlikely to move the market off its current position.
What Does it Mean for Forex Traders?
It means to keep your stops at the ready, because the market is overdue for a correction. The exact catalyst, of course, is up for debate. But the market has created a pattern recently where “bad” news (like higher inflation) is ignored, but “good” news (like stronger economy) is embraced. This has left it somewhat lop-sided, with the potential of a sudden internalization of risk appetite.
Besides commodity currencies, gold could also be in for a correction as well. Many traders might have become complacent after the $30 retracement on Tuesday following the US CPI figures. But that was just a localized price move in gold off all-time highs. A correction in the markets as a whole would likely provide more downside for the yellow metal.
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- Source: https://www.orbex.com/blog/en/2024/03/us-economic-data-doesnt-deter-the-market
