Trade Weighted Dollar Hits A Record High

Stock Market Ends 3 Day Winning Streak

The stock market ended its 3 day winning streak as the S&P 500 fell 0.79% on Tuesday. In the past few corrections we have seen a sharp downturn, a smaller sharp upturn, then a retest of the low, and then a gradual rally until the market hits new highs. 

If that’s the case, we are near the end of this correction as we already had the retest. However, it will be a slow grind higher with a few declines like we saw today. The market is likely biding its time until Powell speaks on Friday.

Specifics Of Tuesday’s Action: Dollar Hits Record High

Nasdaq fell 0.68% and the Russell 2000 fell 0.72%. VIX was up 0.62 to 17.5 as it is slightly elevated. CNN fear and greed index fell back to the extreme fear category as it was down 3 points to 23. It’s clear in this index other markets, such as the junk bond market, are showing more skittishness than stocks. Once again, every single sector moved in the same direction which was down. 

In 6 of the past 7 trading sessions every sector has been on the same page. ‘Risk on’ and ‘risk off’ trades have constantly switched places. The market is still within its zig zag correction phase. I expect it to end up being higher within the next few weeks. Worst 2 sectors were the financials and materials which were down 1.4% and 1.22%.

As you can see from the chart below, the broad trade weighted dollar index just took out its 2002 high which means it is at a record high. That explains why the tech sector has had the worst earnings growth out of any sector in Q2. This latest action further pressures tech earnings in Q3. It partially explains why the FANG stocks have underperformed in the past year. This dollar rally is one of the biggest risks to the expected pop in earnings growth in Q4. Global central banks are cutting rates quicker than the Fed.

The American economy is doing relatively well. America is the only G7 nation that hasn’t had a Markit PMI reading below 50 this year. If the service sector stays strong, that run will continue. August PMI composite flash will be released on Thursday. Consensus is for the composite to increase from 51.6 to 51.9. Manufacturing PMI is expected to increase 2 ticks to 50.2. I wouldn’t be surprised if the latest tariffs hurt sentiment enough for the manufacturing PMI to fall below 50. Investors expect the service sector to keep the composite index above 50.

Market Sees 4 More Cuts In The Next 2 Years

10 year yield is 1.57% and the 2 year yield is 1.52%, meaning the difference between the 2 yields is just 5 basis points. The curve is heading back towards an inversion, which I consider good news. I’d rather see flattening as it means a recession isn’t coming soon. There isn’t much time between a recession and steepening, but this at least proves the economy isn’t in a recession yet. The inversion has been unusual because on average in the past 7 cycles, the short end of the curve has risen above the long end. This time the long end fell below the short end.

The curve may have recently flattened because the market is expecting lower odds of a rate cut in September. On August 19th, the Fed funds futures market saw an 8.5% chance of a double cut. Now those odds are at zero and there is a 1.9% chance the Fed doesn’t cut rates. It’s clear the Fed will cut rates, but this shift is still significant. There was recently over a 25% chance the Fed would cut rates twice.

 On the other hand, the number of rate cuts expected by the end of the year has increased. 1 week ago, the market priced in a 33.3% chance of at least 3 rate cuts in 2019. Now there is a 50.4% chance of 3 more cuts. 

As you can see from the chart below, the market is expecting more rate cuts in the next 2 years than at any point since at least 2005. Even in 2007 and 2008, which was before and during the financial crisis, the market expected fewer rate cuts. The market sees 4 more cuts in the next 2 years. 3 of those cuts might come within the next 4 months.

Weak Housing Starts & Strong Permits

July housing starts report was bifurcated because starts were terrible, while permits and completions were strong. That implies starts will improve in the next few months. July starts were 1.191 million which missed the low end of the consensus range which was 1.21 million. It was down from 1.241 million which itself was a negative revision from 1.253 million. In the NY Fed Q3 GDP Nowcast, the starts reading hurt growth by 9 basis points, but permits helped growth by 21 basis points. The latest estimate is for 1.82% growth which is slightly below the consensus.

Multi-family starts were 315,000 which was a 2.8% yearly decline. Single family starts were 876,000 which is a 1.9% yearly increase. Permits were 1.336 million which beat the high end of the estimate range which was 1.29 million. It increased from 1.232 million which itself was a positive revision from 1.22 million. Multi-family permits were 438,000 which was an 11.8% yearly increase. Single family permits were down 3.8% to 838,000. Finally, completions were up 7.2% to 1.25 million.


Despite the market pricing in more rate cuts than the period right before and during the financial crisis, the broad based trade weighted dollar index hit a new record high. The market is likely biding its time until the Jackson Hole speech on Friday. That’s going to affect expectations for the October and December meeting as the September decision is already locked in. It would be interesting if Trump made a deal with China after getting the rate cuts he wants. That’s pure speculation, but it ties in with my expectation for a trade deal within the next few months.

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