We get the impression that some major sentiment extremes are close. In particular, we appear to be at/near peak optimism about the US stock market and the US dollar, peak pessimism about the US T-Bond market, and peaks in the expected effects of Trump’s policies on US economic growth and inflation. These sentiment extremes are inter-related, in that the very popular view that Trump’s policies will drive US economic growth and inflation upward has magnified the decline in the T-Bond price (the rise in the T-Bond yield), which has, in turn, magnified the rally in the US$.
In the T-Bond market, an intermediate-term reversal is likely during the next month. Possible catalysts for the reversal are more evidence of weakness in the US labour market, a surprisingly low CPI or PCE number, a downside breakout in the oil price, an announcement by the Fed that it is ending QT and a steep pullback in the stock market, but note that with such a high level of general bearishness about the T-Bond’s prospects it won’t take much to bring about the initial ‘turning of the tide’.
At around the same time as or soon after the T-Bond price reverses upward, the US$ should begin to weaken on the foreign exchange market. Further to the comment we made above, this is because it was the rise in the T-Bond yield that extended the US dollar’s rally from its September low to the point where it recently made multi-year highs against most other currencies.
The US stock market (the SPX) also could make an intermediate-term reversal soon, although for two reasons there is a realistic chance that the stock market’s inevitable reversal will be delayed despite the apparent sentiment extreme. One is that the stock market could be given a boost by declining interest rates after the T-Bond price begins to trend upward. The other is that the passive investing funds that now dominate the stock market will continue to support equity prices as long as there is a net flow of money into these funds, and there probably will be a net flow of money into these funds until the economy becomes significantly weaker.
The upshot is that the stage is set for some important trend reversals in the financial world. What we are now awaiting is evidence of reversal in the price action.