MORE BITE THAN BARK - The sharp decline in US equity markets on Thursday was clearly in response to this realization, with the market perhaps finally waking up to the fact that it is going to take more than just incentive from here on to be motivated to be invested in risk assets. Now I won't get too far ahead of myself here and say that the major pullback that I have been looking for is finally underway. But this latest equity decline definitely has more behind it than previous declines, and this time the bark just might be backed up with some legitimate bite. Again, I am not calling for an apocalyptic liquidation of US equities and other risk assets. I am simply looking for the markets to healthily price out this ultra accommodative Fed policy that has over-inflated asset prices for so many months. While it may be true the stock market is trading at normal levels by historical standards and is not overvalued on this merit, I also think it is a pretty good bet to assume that without recent Fed policy stimulus, stocks (record highs) and other risk assets would be a lot lower than where they are now. So is it realistic to expect a 10-15% decline in US equities from current levels? Absolutely. Does this mean it's the end of the world? Absolutely not. This would be a very healthy corrective decline within a still broader underlying uptrend in these assets. But I certainly expect this latest batch of data to alter the Fed's rhetoric and outlook from here on, and this should in turn accelerate policy reversal timelines.
NOT SO FRANC - All of this is good for markets, and especially good for currency markets that have been sitting on the sidelines for several months now. We currency traders aren't used to such droughts, and it looks as though it may be time to buckle up and get ready for a resurgence in currency volatility. I know we have seen a little US Dollar selling since Thursday's data, but I wouldn't expect this to be par for the course in light of what I have highlighted above. My expectation would actually be for a pickup in US Dollar demand across the board (Yen potential exception in the short-term), and I would be looking for higher yielding currencies to start to succumb to the implications of Fed policy reversal and the projected narrowing in yield differentials back in favour of the buck (Are you listening New Zealand Dollar?). I can't say with any certainty that this is IT, and this latest bout of inflation data will be the catalyst I have been looking for, but it is definitely a legitimate contender. Markets are always difficult on Fridays so I won't be holding my breath today, but look for a break below 1850 SPX, and 100.75 USD/JPY to potentially confirm this shifting dynamic within the financial markets. I will add that the EUR/CHF reaction has been most interesting, with the market actually rallying to fresh multi-session highs in the face of the equity and USD/JPY declines. It almost feels as though the SNB is well aware of this risk to markets now, and is trying to buy some time by propping the rate a bit here. But don't mistake EUR/CHF strength this time around and assign it to a favorable risk outlook. In fact, it's probably quite the opposite. Have a good weekend!