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Stocks jump into the green, but dollar doesn’t play along


    • Investors ignore a litany of bad news, push stocks higher on deregulation hopes
    • But FX retains a more cautious tone, dollar holds onto gains as US cases hit new record
    • Texas and Florida “pause” their re-opening plans
    • Rebalancing flows heading into quarter end could bite markets

Stocks and dollar focus on different narratives

The epic market battle between stimulus-driven bulls and virus-fearing bears seems set to end in a draw this week, as worries of a rapid resurgence in virus cases are negated by hopes that an ocean of liquidity will help cushion the damage. Yesterday, US stock markets managed to erase early losses to close more than 1% higher, led by financials, after the Fed watered down its Volcker rule restrictions to free up capital in the banking system.

But the currency market was in a more cautious mood, with the defensive dollar holding on to most of its gains to end higher too, as a litany of negative news kept optimism on a tight leash. This is a quite rare phenomenon these days – stock markets and the greenback typically move in opposite directions, with the 30-day rolling correlation between the S&P 500 and the dollar index being exceptionally strong, and negative.

US coronavirus cases hit a new daily record on Thursday for the second day in a row, magnifying the risk that the most populous US states may be forced to reimpose lockdowns to bring the contagion under control. Indeed, Texas and Florida already hit “pause” on their reopening plans, which might be a first step towards going backwards to stricter measures if their outbreaks intensify any further.

Meanwhile, even though the number of Americans filing for unemployment benefits for the first time declined a little last week, it still remains stubbornly high, painting a bleak picture of a labor market that continues to struggle with mass layoffs even as businesses open their doors again.

Pension funds about to join the bears

All the headlines aside, markets have really gone nowhere this week. Most charts are locked in tight ranges even despite the overwhelming amount of bad news, which suggests that this is a market that wants to climb but isn’t allowed to. Investors are squeezing every last drop out of the few positive headlines out there and are mostly overlooking the numerous negative ones, resulting in a lack of direction.

In the coming days, one factor that could tip the scales in favor of the bears, is quarter-end rebalancing by pension funds that must maintain a fixed stocks-to-bonds ratio. Since stocks outperformed bonds so tremendously in Q2, equities could be hit by a wave of selling heading into month-end as fund managers rebalance back to bonds. This could also spill over into FX through the ‘risk’ channel, boosting safe havens to the detriment of commodity currencies.

That said, the much bigger driver for markets will be how the pandemic picture evolves. If the virus saga takes an unexpected turn towards the better for instance, that could easily eclipse any pension-related selling. If the virus situation deteriorates any further though, these rebalancing flows could exacerbate any market weakness. It’s just a force that will help the bears – it doesn’t mean they’ll win.

US data in focus, but unlikely to matter much

As for today, there’s a raft of economic data out of the US, but most figures might be seen as outdated and are thus unlikely to rattle markets. Still, it will be interesting to see if the consumption data confirm the powerful rebound seen in retail sales.

The important data points will be the daily US virus numbers, especially out of California, Texas, and Florida.

XM.COM Review

Source: https://www.xm.com/research/analysis/marketComment/xm/daily-market-comment-stocks-jump-into-the-green-but-dollar-doesnt-play-along-124041
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