Cornerstone Sees Uncertain Market Ahead, Expects Volatile Rebalancing

One thing that traders can be certain about is that nearly everyone is uncertain.

Trades have become crowded, safe assets have been gobbled up, and the world is back to analyzing Fed speak as if it’s a science. Analysts have started to roll away from the hubris and question the rationality of the current market.

Francois Trahan of Cornerstone Macro laid out a great case for the current uncertainty and what it will mean for prices and markets as we step closer to a U.S. Fed Federal Funds Rate increase.

FX traders have been telling Benzinga is various discussions that they feel the USD trade is too one-sided, too many bulls in the currency. We’ve seen the battle between bulls and bear play out since the beginning of the new year.

The rebalance has helped to moderate the decline in livestock futures but soft commodity and grain futures continue to show disconnects or lagged responses to the dollar action.

Cornerstone notes that a weak USD will revive commodities and will lead to a removal of U.S.-focused equities from the leadership position. Those equities will be replaced with multinationals and will gain further attention as the yield curve continues to flatten.

Psychology plays a major role in pricing and Cornerstone’s own poll jives with a Barron’s poll showing the highest level of participants who are ‘neutral’ since the mid 2000s.  

Barron’s over the weak said the number of participants with a neutral outlook is at 50 percent, its highest level since 2005. Cornerstone’s poll shows participants with a neutral outlook is near 50 signifying uncertainty.

The current state of low growth, low interest rates and low-flation has “left investors in a world where the outcome of major risks are as uncertain as the outcome from the unprecedented monetary-policy accommodation created to resolve them” according to Trahan.

This has never been more evident than in H1 2015 when companies were reporting in record numbers earnings impact thanks to headwinds from foreign exchange.

Global currencies freaked out at the Taper in the summer of 2013 and have only grown more volatile following the 20+ central banks taking interest rate action in the first two months of 2015 along with the Swiss National Bank’s removal of its 1.20 Euro peg back in January.

So what's driving the dollar strength?

According to Cornerstone it’s a mix of the Fed and the global growth story.

The monkey wrench is global growth. This will drive the USD lower according to Cornerstone.

Strength from Europe will offset the Fed and drive down the USD resulting in the disconnect Cornerstone is predicting.