Betting big on a ‘goldilocks’ scenario for the US economy

Markets

The S&P 500 and Nasdaq are riding high, notching their eighth consecutive positive session as stocks continue their winning streak. Investors are pouring back into equities with a renewed sense of ‘full recovery’ confidence, betting big on a ‘Goldilocks’ scenario for the US economy—just the right mix of growth and stability.

With the central bank on the cusp of what’s almost certainly the beginning of a rate cut cycle—potentially slashing 200 basis points or more—investors are laser-focused on Chair Powell’s upcoming appearance at Jackson Hole. All eyes and ears are tuned in, eagerly waiting to see if he’ll give a wink of confirmation to the current market pricing. The market is positioning his remarks to be more consequential than usual, hoping for a dovish signal that sets the stage for the FOMC to cut in September.

But don’t expect Powell to spill the entire rate-cut enchilada just yet. With one more Non-Farm Payrolls report to navigate, the decision between a 25 or 50 basis point cut in September is still up in the air, poised to be the opening act in a multi-rate-cut storyline. Regardless of the specifics, the market is betting on a dovish outcome.

The market has almost shaken off the recession fears that caused a choppy stretch for equities earlier this month. But let’s be honest—if economic data were a TV show, we’d be bracing for a recessionary cliffhanger every week. Major data points will likely continue to show the economy slowing, keeping the recession debate alive with conflicting signals. It will be a wild ride, but the Bulls are in control now.

Trend-following portfolios, like CTAs and volatility control funds, are the market’s cool-headed operators—they buy when things are calm and sell when turbulence hits to limit losses. After offloading during the summer storm, these funds have been pressured to catch up fully during the current calm. But they haven’t yet hit their peak thresholds, which means the street is still in the pain trade higher mode. This environment makes it challenging for bears to sell the tape right now, so expect the market to stay bid on dips.

All signs are flashing green for another day of solid gains across Asian markets on Tuesday. Investors are diving back into riskier assets, spurred on by a weaker dollar and subdued volatility, and the S&P 500 and Nasdaq are riding their longest winning streaks of the year.

The one potential hiccup? Japanese stocks might feel the pinch thanks to the yen’s rally against the dollar. But don’t count them out just yet— with Asia's major exporters all seeing their currencies strengthen, it should cushion the blow in Tokyo. The broad-based dollar sell-off against Asian FX could help take some of the sting out of the yen’s rise, keeping the market action lively and the bears at bay.

While Asian investors will certainly appreciate the drop in US yields on Monday, the real boost to their spirits likely comes from the dollar's broad depreciation. The renewed optimism in Asia ( ex Japan) is much more about the greenback losing ground, making local currencies stronger and, in turn, enhancing the investment landscape across the region.

Forex

As we mentioned over the weekend, we’re skeptical that any rebound in USD/JPY and yen crosses will have staying power. A 20-big figure drop in USD/JPY is hard to ignore—it signals that traders are likely to sell into rallies, especially as we head into a Fed rate-cutting cycle.

Moreover, now that some semblance of calm has returned to Tokyo markets and USD/JPY is starting to align more closely with the current rate differential, the Bank of Japan might even inch towards policy normalization. In this scenario, I seriously doubt we’ll see any significant revival of the carry trade via the JPY, as the dynamics have shifted more bullishly for the yen.

Bearish dollar momentum is gaining steam as we head into the Jackson Hole event. The default narrative here centers around EUR/USD, especially with the Fed on the cusp of easing amid softer US activity data. Real rates will be the key driver for this trade, with an expected test of 1.1100 likely to pave the way for a swift move towards our 1.1200 target by September. It’s shaping up to be a pivotal moment for the euro, and traders are starting to position accordingly.