HomeSolutionsInsightsNewsroomPeopleContactLogin

Acclaimed macro analytics
Portfolio Construction & Risk Management
Trading Solutions
Macro Models
Thematic equity baskets

Announcements
Press
Blog

The chart shows US & European 5y inflation expectations in z-score terms. Both are running above long term trend but the most noticeable feature for the last month plus had been the divergence between the two.

The global energy crunch hit Europe harder which experienced a 2 standard deviation move in inflation expectations. That erosion in real yield support was negative for the Euro & helped push macro fair value for EURUSD down towards 1.15. If this re-convergence proves sustainable, the 3 month downtrend in macro-warranted model value for EURUSD could be coming to an end.

This catch up in US inflation expectations will have broader implications. Which are the best inflation hedges currently? Qi’s “Commodity Super Cycle” watchlist suggests commodity energy markets are rich (though not in regime), while most commodity currencies have already priced a degree of good news. Base metals & certain mining stocks (Freeport, FCX & copper miners ETF, COPX) have lagged, sit in regime & at macro fair value.

Furthermore, Q3 earnings season will no doubt focus market attention on those stocks that enjoy pricing power versus those experiencing margin compression. Equity investors know their style tilt – the degree to which their portfolio favours growth over value, momentum or quality – but can they quantify the relationship their holdings have with inflation expectations?

It’s geeky but, in short, negative basis swaps imply the cost of accessing USD funding is becoming more expensive for foreign banks. In the chart below for example, note the huge spike lower / squeeze in USD liquidity in March 2020 with the first economic lockdowns.

The chart shows USDJPY cross-currency basis specifically & in z-score terms. So the recent sudden leg lower below the zero bound implies tighter USD liquidity for Japanese institutions.

Any asset with a positive relationship to this factor needs easier USD liquidity to perform; & conversely, will suffer as US liquidity tightens.

The US debt ceiling issue was threatening to become a meaningful headwind for such assets given the factor move above. That move may abate near term but could easily re-appear as a critical driver of markets if the whole stand-off is repeated come December.

It’s early days but S&P500 model confidence has risen 24% in the last 2weeks suggesting a new macro regime could be forming & cross currency basis swaps feature as a top driver. If that relationship holds, another significant tightening of US liquidity in December could be a far bigger deal for US equity markets.

That represents a perfect round trip since “Suga high” on September 6th when the Nikkei was 1.3 sigma (4.1%) rich on Qi. That flag was a little early (the Nikkei peaked a week later) but the message was simple – while politics had powered the rally, Japanese equities were in a strong macro regime & at valuations that look stretched. What’s the macro picture now?

Nikkei model confidence dipped (in line with its global peers) but critically stayed in a macro regime – a regime that emphasises domestic reflation (rising inflation expectations & a steeper yield curve) & easy financial conditions (Central Bank QE & tight credit spreads).

That combination of macro factors are offsetting each other such that macro model value is currently moving sideways. Hence the sudden & substantial Fair Value Gap.

How significant is this FVG level historically? Since 2009 there have been 13 occasions when the Nikkei has been in regime & 1.3 sigma cheap to model. Buying the dip has produced an impressive 85% hit rate for an average return of +7.6%.

As always, this time could be different. It feels like equity bears are gathering a bit of momentum right now. But it ‘felt’ like Suga’s resignation was going to be the catalyst for the great Japanese catch-up trade. For those who believe this is merely a correction, one of the world’s most cyclical assets is presenting an interesting opportunity.

Last week, poor results from Bed Bath & Beyond saw the stock fall 20% plus. Qi’s BBBY model is not in regime &, as such, the 1.9 sigma (46%) deficit between spot & macro fair value, comes with a health warning. Note though model confidence has risen nearly 20% in the last month &, at 53%, is close to forming a new macro regime.

It is noticeable that the drivers of this fledgling regime are similar to the broader US Retail sector. XRT model confidence is high (71%) & stable. Retail bulls want domestic US reflation (higher real rates, steeper yield curve, rising inflation expectations) married to global growth & no stress in China.

Together that mix means Qi macro warranted fair value is currently trending sideways. Last week’s sell-off means spot price is diverging lower. As a result, XRT is 0.5 sigma (4.7%) cheap to model. That’s close to a 1y low for the FVG.

XRT may be too broad a vehicle. Some may argue fiscal stimulus plus suburbanisation / home improvement trends combined to give previously beaten up old school retailers a lift; & now, as the tide goes out, the bricks-&-mortar versus online retail split will reassert itself.

Fair, but note online retailers have also been caught in the downdraft. IBUY is now 0.5 sigma (3.2%) cheap to its macro environment. A buy the dip opportunity for a secular outperformance trend; or, could there be a broader message about US growth at work?

Each cell in the grid below shows the Qi Fair Value Gap for that FX pair. The bigger the positive (negative) FVG the deeper red (green) the cell is coloured. Black font in the cell means the cross is a function of macro factors; when greyed out, that model is out of regime. Read down each column to get the aggregate picture for any one currency versus its peers.

Every USD fx pair is in a macro regime. Crudely, half are close to fair value, & half show the Dollar as modestly cheap. The two book-ends are AUDUSD where RETINA™ has posted a bearish inflection signal, & cable.

The recent spike in risk aversion has moved AUDUSD model value down below 0.70 leaving Aussie rich & vulnerable. It looks the best G10 candidate for those looking for further USD strength.

Indeed, Aussie crosses are consistently in macro regimes & rich. While that may surprise some given the 2.7% fall in Aussie TWI since the end of June, that fall has not kept pace with the macro factors – China, commodities, rate differentails, risk appetite – that currently drive it.

Cable is the one cross where the USD is rich: +1.1 sigma or 1.3% above model. Moreover, Sterling is consistently cheap, maybe confirming what some see as its new status as an EM currency.

Marrying the two together, contrarians might want to look at GBPAUD which is now 1.75 sigma (3.9%) cheap to model. Since 2009 longs set at this FVG result in a 67% hit rate & +0.9% median return. Though most of those signals were before the secular shift that is Brexit.