Forex Trading Library

The Big Short: Has the Market Peaked?

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Yesterday there were two things that coincided which probably raised the eyebrows of a few traders. First was the news about Michael Burry. He’s famous for having predicted the collapse of the subprime market, and there was a movie made about it called “The Big Short”. Well, he’s sort of doing it again by betting over a billion dollars that the market will tank in the coming months.

Then global indices closed lower, with all three major US stock markets falling more than a percentage point. How’s that for timing? Well, it’s worth looking into the drop in the stock markets, because something else interesting happened that is very relevant to forex traders: The dollar was largely unchanged despite the market drop.

What’s going on?

The situation is a bit unusual because typically the dollar goes in the opposite direction from stocks. This is because the dynamics of the market are driven by money shifting between the bond market and the stock market. If investors think things are doing good, they want to be in the stock market, and move money out of bonds into stocks. This causes treasury prices to go down and drags on the dollar.

If markets are worried about the future, they want to be in the relative safety of bonds. So, when the stock market goes down, Treasuries typically get a boost. But if both move in tandem, it’s a sign that there is something else going on besides the usual risk-on/risk-off dynamics in the market.

The data was good, so why did the markets go down?

The dollar already gained on Monday as investors weighed the impact of a host of negative data from China. From falling industrial production to slower trade, Chinese economic indicators have been bad enough that economists are now warning the country might not meet its growth target for this year. Meanwhile, US retail sales jumped faster than expected. In fact, the retail sales data were so good that the GDPNow tracker from the Fed boosted its projection for annualized GDP growth this quarter to over 5.0%.

Markets had a negative reaction because strong retail sales means that price pressures are likely to keep up. Which could mean inflation remains a problem, and the Fed will have to do something about it. The market has been expecting that there will be no more rate hikes this year. But, if prices keep going up, then the Fed will have to raise rates, and that will have a negative impact on the markets overall. The thing for forex traders is that it also implies that the dollar should be stronger.

So, what happened to the dollar?

The dollar index is near the highest it has been in over a month and a half, as markets worry about global economic growth. China was expected to drive growth, with the US looking at some kind of “landing” for its economy. But, it seems things are shifting, and the market is increasingly starting to believe the US will avoid a recession. With China underperforming, the US could be the driver for economic growth in the rest of the year.

But, while investors speculate that the US could avoid a recession, they aren’t putting their money on that bet, yet. Forward futures are still pricing in near a 50-50 chance of a recession in the US. Despite speculation that better retail sales “could” translate into more Fed action, traders’ expectations for the Fed were unchanged. Hence, no boost for the dollar. Traders, apparently, are worried about performance in the stock market, but are also not yet convinced that the problems are worrisome enough to pile into bonds.

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