UK Inflation Catches Momentum Models by Surprise

When evaluating the performance of our momentum models we are considering the average performance across the one-, three-, and 12-month momentum models.

Summary

• Momentum models slipped 0.3% WoW paring some of last week’s +0.5% gain.
• Performance over the past three months remains marginally positive, due to strong equity momentum model performance (+4.8%).
• Since our last update, momentum models have turned heavily bullish on the DAX, pared US 10Y, bund and gilt bearishness, while base effects impacted EUR/CHF, NZD/USD, and USD/CAD signals.

Latest Signals

Equity momentum models turned heavily bullish on the DAX as the index crept further above 16,000 (Chart 1 and Table 1). Elsewhere, they remain heavily bullish on the S&P 500 and heavily bearish on the FTSE-100.

Meanwhile, rates momentum models pared US 10Y, bund and gilt bearishness and added to JGB bearishness. Otherwise, they remain heavily bearish on the US 5Y and US long bonds.

Base affects in the 12-month lookback models drove the FX momentum models changes (Chart 2 and Table 2). EUR/CHF signals turned less bearish, NZD/USD signals turned less bullish, while signals flipped bullish for USD/CAD.

Model Performance

Rates momentum models (-1.2% WoW) underperformed across the board over the past week, though gilts momentum models (-3.5% WoW) notably led to move as UK inflation offered a path for a Bank of England (BoE) pause. We, however, were well positioned for the release: we remain short the UK 10Y inflation swap (target: 3.65%; stop 4.0%), short 1Y1Y US OIS vs 1Y1Y SONIA (target: 100bps), and long EUR/GBP (target: 0.89; stop loss: 0.845).

In equities, while most models were positive, led by the momentum model for the S&P 500 (+1.9% WoW), the momentum model for the FTSE-100 (-2.3% WoW) proved a drag on overall performance (+0.2% WoW).

Across FX, EUR/USD was the biggest winner (+0.6% WoW), while NZD/USD was the biggest loser (-0.5% WoW). On average, FX momentum models were flat over the past week.

Returns are marginally positive over the past three months due to strong equity momentum model returns (+4.8%) – rates: -0.1%; FX: -0.9%.

Our Views

In the US, attention is fast turning to the July FOMC meeting. Dominique believes a 25bp hike is a done deal. The clarification of the Fed’s reaction function will be the most interesting development given there is no SEP, while Chair Jerome Powell is unlikely to provide hints on the September FOMC. Post July, Dominique continues to expect a hike at the November FOMC meeting, with the Fed continuing to prioritise its unemployment target. This should allow term premia to creep back into the curve and we see value being long Bunds vs USTs.

Moving across the Atlantic, UK inflation’s miss adds further to Henry’s feeling that the BoE does not need to hike as far as the market is pricing.  While the BoE should not read too much into a single month’s positivity, the details of services inflation show that wages are not the main driver of cost pressures. In fact, Henry finds that the BoE has probably already done enough to crush inflation, although he expects given their reaction function that they will need to keep hiking in the near-term.

Shifting to EM, Caroline finds that a rising services surplus and a lower energy dependency versus Hungary explain the rapid correction in Poland’s current account, with the May deficit at just -0.3% of GDP. Meanwhile, Bert remains reluctantly in the LatAm FX carry trade.

Lastly, Bilal believes FX market dynamics appear to be shifting while Dalvir finds the EUR/USD volatility curve suggests buying 6M implieds and selling 1Y implieds.

*The basic strategy is to use returns (lookback windows) to give buy/sell signals. So, if the US stocks are up over the past 3 months, you buy, otherwise, you sell (note I use excess returns).

Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.

Ben Ford is a Researcher at Macro Hive. Benjamin studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively.

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)