Is risk about to sell off again?

I’m finally back from my summer travels, and have the bandwidth to resume my usual cadence of delivering full posts!

S&P futures are 6.4% off the Aug 5 lows, undoing the entire selloff since the weak employment number. VIX is back at 17.5, and a 50 bp cut in September is now only a 50% probability vs a 25 bp cut. In hindsight, market pricing of an emergency Fed cut seemed ludicrous. Was the yen carry trade unwind just a one-off volatility shock, or was it the first tremor in a more prolonged recession regime? I believe it was the latter, and that the current rally in risky assets, whether we are talking equities, USD/JPY, or crypto, should be sold.

Equities have benefited from a couple days of good data. First, we got a stronger than expected ISM services number on Aug 5, followed by a stronger than expected jobless claims the following day. The stronger numbers defied the narrative that the US economy is falling quickly into recession. We were then served a disinflationary PPI and CPI number yesterday and today, further fueling the squeeze. The gyrations in economic data surprises are to be expected, but the general trend has been towards a weaker economy.

Going forward, we will continue to swing between volatile recession regimes and calm disinflation regimes. Volatility expansion and contraction. Deleveraging and releveraging. Traders should be nimble enough to turn their positions around on a dime, and have the fortitude to sit on their hands during the choppy periods of calm.

For traders trading my time horizon, the key is to understand the positioning of the market and its expectations about the path of the economy. On Aug 5, when USD/JPY was at 142 and Fed funds futures were pricing in 150 bp of cuts over the next three FOMC meeting, the market was positioned for a sharp and dramatic economic slowdown, and was forced to deleverage all of its risky positions at extreme prices. Today, with the S&P 500 only 5% off the highs and 109 bp of cuts priced for the rest of 2024, the market is now pricing in a soft landing, Goldilocks environment where the Fed can cut at a leisurely pace to avert a recession.

I believe that reality lies somewhere in between the two scenarios. Risk shorts have been squeezed, and positioning is now much cleaner, paving the way for the next risk selloff. Maybe the trigger will be a weaker than expected US retail sales or jobless claims tomorrow. Market volatility is the forcing function that spurs the Fed to deliver the large and fast cuts needed to avert recession.

A few interesting FX charts:

EUR/USD has been sideways for one and a half years. Perhaps this break higher is a leading signal for USD weakness across the board.

Weekly EUR/USD

USD/SGD has been in a 1.30-1.45 range since 2015! The range has lasted so long that I had to dust off the monthly candlestick button. SGD trades as a managed basket of currencies, with the largest non-USD components being CNY, Malaysian Ringgit, and EUR. It’s a good barometer for how USD trades against both Western G7 countries and Asian currencies, so when USD/SGD starts to press the bottom of its range, my attention is piqued.

Monthly USD/SGD

I’m inclined to find short USD trades that fit my recession regime view. These trades should exhibit strong relative strength (or weak relative strength, since we are talking about risk-off) and good risk-reward.