2025.02.24 Weekly

Stagflation vibes

‘Stagflation’ is the main macro theme driving my trading views while assessing that against the incoming data to see if it has multi-week legs — short cyclical assets, long defensives/safe-havens. Book is short equities and long JPY (versus USD EUR and AUD currently).

Data review

Last week’s flash PMIs showed a notable deceleration in the US, a deeper contraction in France, while others showed some further improvement. US Services PMI saw the first contraction reading in 25 months; Accelerated manufacturing expansion in US and Australia, Europe and Japan remained in contraction but saw improvements while UK manufacturing deteriorated further. Some snippets from the US and Euroarea reports:

• US — “Optimism about the year ahead has slumped from the near-three-year highs seen at the turn of the year to one of the gloomiest since the pandemic. Sales are reportedly being hit by the uncertainty caused by the changing political landscape, and prices are rising amid tariff-related price hikes from suppliers.”
• Euroarea — “price indices for the services sector have risen or remained at a high level; wage settlements continue to be above average; input prices for goods are now rising more sharply; services sector is showing renewed signs of weakness, after two months of moderate but still visible growth the rate of expansion has now weakened considerably; accompanied by a decline in new orders and an accelerated decline in order backlogs. Economic output in the eurozone is barely moving at all; these figures do not yet point to a recovery in the eurozone.”

Slowing business activity and rising prices.

US economic surprises made a new 5-month low while other major economies are on an improving trend — e.g. European sentiment improving; UK saw stronger than expected labour market, retail sales and inflation data. But despite some encouraging months outside the US, stagflationary signs were already brewing the prior month on rising cost pressures and slowing business orders — both of which intensified in this month’s reports. Adding to higher staglfation risk outlook, we’ve also had a lot of Central bank comments last week and the general sense is that they are expressing a reluctance to continue cutting rates while there is a higher degree of geopolitical uncertainty amid continued price pressures.

Looking ahead

I don’t expect this week’s data to be too market moving — CB consumer confidence expected to be weaker, 2nd GDP release unlikely to deviate from expectations, and neither should PCE. I would therefore expect the weakening economic data trend to continue dominating the narrative til ISM and labour market data in the following week.

Equities

The SPX has so far pulled back 2.13% from the Wednesday record close with the Friday sell-off ending at the 50dma, which has been a decent reference point to be buying shallow dips. The question becomes whether this correction will be another shallow dip, or something more. I would argue that this is only the start of a corrective phase for the SPX.

Technically, despite making new all-time highs last week, price action has gotten compressed and now resolving with a break below the YTD-trendline support, momentum oscillators exhibit a bearish complexion with stochastics crossing below the signal line, and RSI breaking lower below the mid-line. Also, large declines in the US economic data surprise index as noted earlier have all coincided with pullbacks of 5% of more (arrows) over the last year extending well below the 50dma.

For SPX gains to be considered healthy (for the most part), cyclical stocks needs to pull their weight, which they have done in the late 2024 run-up. But they’ve clearly gotten concerned by the weaker than expected run of economic data over the past month. While we probably shouldn’t be overly concerned by this — rates of change do matter, and it's looking likely that the cyclical run up has peaked, at least until US data starts to impress to the upside again.

Call volumes continue to dominate though the Put-Call volume spread has pulled back from the Feb-14th extreme (circled). I suspect this spread will continue to revert higher on the changing growth narrative.

SDEX (put premiums) continued to inch higher alongside the SPX’s grind to new all time high on Wednesday, highlighting some underlying fear and demand for downside protection. The week ended with a big jump higher into the Friday OPEX which could beget more downside volatility for the week ahead. You may recall those yellow boxes from my note a couple of weeks ago to indicate my expectation of a higher vol regime ahead — still looks the case so far.

Also an interesting SPX statistic I looked into on Friday — I vaguely knew from experience that OPEX days were strong points on the calendar to take counter directional views, but I must say — very surprised to find it being so one-sided.

Finally, a look at SPX breadth metrics shows upside momentum has been lost last week with the majority of SPX stocks (47.9%) going below the 100-day moving average and, the majority making new 3-month lows.

While it may be tempting to start buying dips with many stocks hitting/approaching some major moving averages with confluent pivot levels, there is still ample room for these metrics to deteriorate further. We are still far from oversold extremes being less than a standard deviation below the 1yr average, and as things are at the moment, I personally would not consider buying dips (or squaring up shorts) until we hit -2sd levels.

Commodities

BBG commodities index is setting up for a corrective leg across the board, generally following the Friday pullback in economic surprise indices and a weaker growth narrative building.

Going clockwise from top-left: Industrial metals exhibits a weak price action structure; Precious metals looking slightly weaker structurally but will probably stay resilient on the weakening growth outlook; Energy sharply reversing from the prior swing high; Agriculturals breaking the strong uptrend.

Rates

US yield curve has shifted lower over the last 2 weeks, particularly at the front end relative to the longer end last week (Red) reflecting the bull steepening response to the weaker economic data.

SOFR implied rates, as a result of the weaker data, are moving back towards 2cuts after pricing in the possibility of less than 1 at the beginning of the year.

But while the activity data has been weaker, I think some upside inflation risks (as reflected by short-term inflation swaps going higher since election) will keep cut expectations in that 1–2cut region.

That makes me think that the 10yr is at risk of heading to 4.35% and will probably need ISM and NFP the week after to weigh in for further direction. Base case for this week is that I think it will stay stuck to the low end of this 4.4–4.5% area.

FX

G8 FX fixed weight index daily performance last week:

JPY was a consistently strong performer after some stronger than expected growth and inflation data last week while G8 bonds were broadly on the bid — I think we will see much more of that over the coming weeks.

In fact, I consider long JPY as being my highest conviction theme since the long USD view taken during Q4 of last year, based on the weaker growth narrative, elevated vol regime to keep safe haven JPY and USD on the front foot (except for CHF which I think will struggle to keep up due to the strongly negative carry), and plenty of JPY upside risks with data continuing to come in hot as we approach the spring wage negotiations that will be finalised around mid-March.

For EUR, there seems to be pattern of misplaced optimism — Ukraine war ending, Russian gas supply coming back, and this time around the German elections. I agree with ING’s comments that it is far too early to be optimistic about the positive impact of even the best-case scenario (i.e. Merz forming the ‘grand coalition’ with the SPD).

From a trading perspective, I still contend that EUR is a sell on rallies and should it get a pop on a ‘grand-coalition’ being formed, I think that will mark the peak in EUR optimism and thus a good time to crank up the shorts.

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That’s all for now, good luck trading.