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1. Are we any the wiser post the FOMC? SPX Sensitivity to FCI rising

Chair Powell stuck to the narrative that the inflation surprises this year are just bumps in the road, rather than taking the Fed to a different route. Does this tell us anything new? What strikes us is how much uncertainty there is – whatever the Fed pricing is, the uncertainty band around it has expanded a lot. Lest we need a reminder, at the start of the year markets were convinced we would see a series of cuts. At the end of end of the day it is the data that will drive sentiment and whether we can thread the needle for a soft landing. Apple reports tonight followed by payrolls (which have been stronger than forecast for each month so far this year).

Financial conditions (real rates, HY credit spreads, DM FX, inflation expectations) have been primary drag to SPY’s Qi model value over April, spilling over to higher risk aversion also. Qi’s SPY sensitivity to financial conditions can be seen as a barometer of the market’s fear of the Fed’s policy reaction function. With this in mind, we note in the first chart that the SPY sensitivity to financial conditions is becoming more negative again. Stocks navigated Q1 well despite the rise in sensitivity precisely because FCIs eased post the Fed pivot (alongside a reflationary mindset). If there is rising uncertainty it is more likely SPX moves more in line with FCI.

The second chart plots major indices and sector ETFs across two variables – their Qi fair value gap vs. their Qi macro-warranted value and their sensitivity to US FCI (as defined above). Clearly, the vast majority risky asset benefit from easier FCI, some more than others (see Observation # 2).

2. Any Taper Tantrum for FX?

At the margin, the Fed’s QT taper was more aggressive than anticipated.

The new monthly ceiling of $25bn is only modestly below what was expected. But, to the extent it removes some of the pressure on the bond market in terms of how much UST duration it needs to take down, it can also be seen as helping limit the upside in US yields & therefore a potential headwind for the Dollar.

Qi employs rate volatility as a proxy for Fed QT expectations & it is a factor in every G10 Dollar model. The chart below shows the percentage impact on each $ pair for a one standard deviation increase in our Fed QT factor holding other factors stable.

The cross most sensitive to the Fed’s balance sheet right now is USDSEK. On current patterns, the Dollar appreciates 0.39% for every one sigma increase in US rate vol (Fed QT expectations).

Put another way, USDSEK is the pair most vulnerable to a dovish shift in the Fed’s balance sheet policy. USDSEK is also the richest $ cross amongst G10 pairs on Qi. It is 0.8 sigma or 2.4% above macro-warranted model value.

A level that back-tests well (65% hit rate) as a bearish signal & one where recent history vindicates the idea that the mean reversion happens via spot catching up or down to Qi model value. In short, for anyone believing last night’s taper announcement was big news, USDSEK looks the most efficient expression.

3. Rising concerns on US consumer? XRT is the most sensitive US sector to financial conditions

Amazon’s CFO said: “Customers in the US are being very thoughtful about their spend. They look for deals, they trade down and look for lower ASP (average sale price) products.”

Starbuck’s CEO said: “ We continue to feel the impact of a more cautious consumer, particularly with our more occasional customer and a deteriorating economic outlook has weighed on customer traffic and impact sales broadly across the industry”
Meanwhile Harley Davidson sharply fell last week on rising dealer inventories.
Together, signs that consumers are becoming more cautious.

With this is mind, below we show US sector ETF sensitivity to FCIs (the CDX HY corporate credit spreads, real rates, and rate vol). The most vulnerable sector to tighter financial conditions is XRT (which excludes Amazon & Tesla). This is followed by banks, long duration (biotech), homebuilders / construction and real estate.

And XRT macro momentum has decidedly rolled over…

4. Any disappointment is being pounced on; same goes for any cracks in the growth outlook – watch Qi GDP Growth Basket and US Industrials

We previously said that the onus on this earnings season was high – if the Fed policy reaction function has now become uncertain any cracks in reflationary narrative would be pounced on. This earnings season has shown that poor messaging is being punished. Likewise, if the FCI outlook has just become more uncertain, risky assets will want supportive economic news i.e. not for talk of stagflation to take hold. Note just this week we saw a dip in ISM Mfrg back below 50, but a jump higher in prices paid to 60.9 (55.8 expected). With this in mind, two observations:

1/ Qi’s GDP growth tracking basket has started waning over the last month, alongside a fading Citi US Eco Surprise Index. See the first chart.

2/ US Industrials have been outperforming the broader market since the start of February. From a Qi perspective, the price relative of S5INDU vs. SPY screens rich to it macro-warranted fair value at +1.3 sigma.

5. Stay away from “Bond Proxies” are among the richest sectors to Qi macro-warranted fair value in the US:

Qi shows utilities and staples as the richest sectors in the US. A simple overlay of these classic bond proxies (below we show an equal-weighted basket of XLU, XLP, IYZ, USRT) vs. the 10yr US bond yield highlights the reason why.

Ordinarily, these sectors would favour lower US rates. However, this year they have not traded like traditional bond proxies. Given their rich status, a hawkish Fed will challenge the ability of these sectors to act a defensive hedge. While a dovish Fed message does will not offer further impetus. In our view, this make convergence in the jaw gap below compelling.

6. But if you are looking for something that goes with a lower dollar…

MNST (Monster Beverages) is trading cheap to its macro warranted fair value ahead of earnings today and among its largest factor exposure is to a lower USD.

Qi is showing that the weak Yen is no longer a positive for the Nikkei – global investor reluctance appears to be rising as JPY weakens.

Some commentators have argued we are now in a secular bull market for Japan, similar to 1960s into early 70s when Japan strongly outperformed the rest of the world. This case is made on the basis of geopolitics - Japan is fast becoming the high-tech production hub for the Western hemisphere; political pressure to create demand-driven inflation; an acceleration in corporate reforms. A byproduct of this has been a weakening JPY which has been encouraging greater inbound tourism also.

Over the last 1yr, the Nikkei has returned 31.5% in local currency terms (vs. 30% for the Nasdaq), setting a new ATH. In USD terms, performance has been more disappointing – in fact, YTD the Nikkei” has underperformed SPX by ~ 4% in USD terms. On Qi the weak Yen/ strong Nikkei relationship is also waning:

Qi macro-warranted fair value for USDJPY, is struggling to get past 154-155. However, this is not a core tenet of the Nikkei thesis.

While the sensitivity to USDJPY , is still negative, Japan GDP Nowcast, DM economic confidence (proxied by tightening peripheral European govt bond spreads), copper and falling rate vol have been dominant drivers of Qi model value over the last 2mths. Nikkei strength does require a reflationary narrative.

This has left investors with the question of whether the current dip is seen as a buying opportunity. At the global index level, the Nikkei is the global value play using Qi’s framework. It is currently the cheapest index globally on Qi’s framework. The Nikkei is trading at -1.2 sigma (-10%) to Qi’s LT model value. That gap is particularly large vs. history, especially as macro confidence starts to rise from the decline over Q4 2023

Qi sees this value also on an RV basis – BOTH in local currency and USD common currency terms. A key driver of this value of later has been the higher sensitivity of SPY to US FCI / wider credit spreads. It has been noted that several global indices have been outperforming the US, even the almighty Nasdaq (in LC terms) – the FSTE A50, Nikkei, Euro Stoxx 50 etc. Europe, Japan, China are all seen a reflationary, value plays if we are remain in a world where growth remains robust but where the US potentially has a stickier inflation outlook.

Qi sees this value also on an RV basis – BOTH in local currency and USD common currency terms. A key driver of this value of later has been the higher sensitivity of SPY to US FCI / wider credit spreads. It has been noted that several global indices have been outperforming the US, even the almighty Nasdaq (in LC terms) – the FSTE A50, Nikkei, Euro Stoxx 50 etc. Europe, Japan, China are all seen a reflationary, value plays if we are remain in a world where growth remains robust but where the US potentially has a stickier inflation outlook.

Qi sees this value also on an RV basis – BOTH in local currency and USD common currency terms. A key driver of this value of later has been the higher sensitivity of SPY to US FCI / wider credit spreads. It has been noted that several global indices have been outperforming the US, even the almighty Nasdaq (in LC terms) – the FSTE A50, Nikkei, Euro Stoxx 50 etc. Europe, Japan, China are all seen a reflationary, value plays if we are remain in a world where growth remains robust but where the US potentially has a stickier inflation outlook.

1. Attributing the pullback to macro – financial conditions and risk aversion are front & centre

The S&P500 index has fallen x.x% from its local peak on 28th March. Qi's macro return attribution model is able to reveal the macro components of the drawdown thus far - important for any risk manager to understand as cross-asset vol rises, alongside any traditional style / industry exposure analysis.

Through a macro lens, the largest drags have come from risk aversion and financial conditions. Risk aversion is proxied by VIX; while the primary drag within financial conditions comes from wider HY credit spreads, dollar strength and higher Fed QT expectations (i.e. rate vol). The pullback thus far has NOT been about growth concerns - indeed, in aggregate the component of returns from our growth expectations bucket has been positive. Specific returns are the residual of returns that cannot be explained by macro - this component is also positive. In other words.

2. The S&P500 Macro Beta Impulse is also starting to rise led by sensitivity to real yields and the dollar

Had apathy grown about the ability of equities to rally regardless of the news?

We have said in several recent reports that risky asset vulnerability would be reflected in
1) Falling model price momentum and
2) A rising macro beta impulse. Both of those boxes are now ticked.

Further, we are seeing signs that financial conditions are starting to matter – it is not merely about the growth outlook.

We had previously commentated that in Q1 the S&P500 sensitivity to real yields almost turned positive – a reflationary mindset.
That is now changing into Q2 where we see the sensitivity to real yields turning more negative – a sign of market nervousness.

3. All eyes on Janet Yellen

Her "serious concerns" comment effectively gives the Japanese a green light to intervene in USDJPY. She is also in charge of the Quarterly Refunding Announcement due in 2 weeks time.

Aside from earnings season, these are arguably the two most important bits of event risk facing markets today. The preferred scenario for risky asset bulls is:
1.) MoF intervention - it has marked the top in the Dollar & US yields on the previous two occasions they've stepped in
2.) a repeat of November's QRA that skewed US debt issuance from bonds to bills &, alongside the Fed pivot, was the catalyst for the "everything rally" over the last 5 months.

If that transpires, FX players will be back seeking strategies that work in a low vol, high carry environment. On Qi, USDMXN looks the most interesting for believers in a Dollar reversal.

It's been 0.8 sigma (1.9%) rich to macro & in regime just 8x since 2009. Back-testing that FVG as a sell signal elicits a 63% hit rate & +1.5% average return. Over the last year Qi's FVG & spot price have posted a strong correlation suggesting there's good risk-reward on the current gap closing the 'right' way.

4. SANOFI – Cheap with Interesting Macro Exposure Characteristics for Portfolio Construction

• Sanofi is cheap to the Qi macro warranted model price by 1.2 standard deviations or 8.4%
• This is close to the cheapest it’s been in the last year on macro model valuation while macro has been significant in terms of explanatory power of share price
• The drivers are also interesting for portfolio construction purposes as they are fairly opposite to the SXXP index, Sanofi wants

1. Higher inflation
2. Higher real rates/credit spreads
3. Lower GDP and a flatter curve

• Stock was hit in Q4 last year owing to concerns about further R&D spend and Q124 earnings are out next week

5. Market breadth stifled - US Technology model momentum now waning, led by the more speculative end i.e. ARKK

In a sticky inflation world, the improvement in S&P500 breadth is now stifled and folk will try to hide in quality, mega cap tech over small caps and bond proxies. However, this isn’t really a great recipe for a risk-on market. For breadth, we need speculative areas to outperform. See the first chart.

We track Qi model price momentum across all securities. Zooming in on our universe of 179 equity ETFs, we note that only 25% of this subset have seen their macro warranted model value rise over the last 4wks. See the second chart below. Digging further into where macro momentum has been weakest, we see the more speculative end of Technology as the biggest laggards e.g. ARK Innovation, Biotech, ARK Next Generation Internet, Global Autonomous and Electric Vehicles etc. Indeed, these pockets are the most sensitive to financial conditions.

Qi has constructed a measure of the US credit impulse which speaks to financial conditions relative to trend. Be aware that credit has now turned a net headwind for markets / the economy. See the third chart.

6. Across commodity equities, energy still cheap to macro model value but precious / base metal equities still rich

In the scenario of a Fed policy error actually manifesting, the dollar would ultimately succumb to weakness. The equity market destination would be commodity sensitive equities, in the desire to increase exposure to real assets.

However, there is a distinction to be made within commodity equities. Recently, we highlighted GDX as a sell idea – dislocating from higher real yields and dollar strength. While GDX has started to weaken, it is still 1.7 sigma rich to Qi’s macro-warranted fair value. Alongside, COPX (Global Copper Miners) is still 0.6 sigma rich (first chart below). Copper itself is particularly sensitive to financial conditions, namely rate vol and CDX HY. Copper is 2 sigma rich to its Qi macro-warranted fair value.

The flipside is that US Energy equities trade cheap to their Qi model value and at the cheaper end compared to its US sector peers. Particularly, on an RV basis to US Financials (see the second chart below).