FYI | Mar 05 2014
By Kathleen Brooks, Research Director UK EMEA, FOREX.com
The chart below is a bit of an eye opener. It shows US economic data surprises, along with the S&P 500 and the dollar index. As US economic data has been missing expectations, the S&P 500 has surged to fresh record highs (orange line in the chart below). So are stock investors ignoring the weaker data, which have been fairly broad-based this year, and can stock valuations be justified at this level if this continues?
Understanding the weather-effect
The first thing to note about this chart is that negative US economic surprises are close to their highest level since mid-2011.There is a caveat to this, the bad weather at the start of the year has been blamed for some of the data misses in recent weeks, thus, the negative surprise index could be over-stating things a little. The sectors where negative data surprises have been the worst include housing and real estate, followed by retail and survey data. This adds to evidence that some of the data misses could be impacted by the cold spell, as retail and housing are sensitive to extremes in weather. In contrast, the personal and household sector has actually surprised expectations. Thus, as the weather picks up we could see a an improvement in this index.
The pressure is on
While the weather may be to blame for some of the data misses, this also means there is a lot of pressure on US data to start beating expectations and to bring the surprise index back to positive, or at least neutral, territory. The Non-Farm payroll survey for February is considered one of the biggest data releases each month, so there is a lot resting on this Friday’s report. Another month of disappointing job creation in the US could trigger a sell-off in in stocks, which have turned a blind eye so far.
The market impact so far
Typically, moves in the stock index can be preceded by moves in the surprise index, for example, a spate of positive or negative surprises may impact the direction of a stock index. Although economic data surprises and stocks have diverged in the past, they tend to have a slight positive correlation, so data misses may coincide with periods of weakness in stocks. However, this relationship is at best loose, since in mid-2012 the index kept rising even though data surprises turned negative. So there is a precedent to what is happening today. However, the question now is, can this index break fresh record territory if the data is not there to back it up?
The dollar:
This chart also shows the US dollar index (yellow line on the chart). The DXY has been weak at the same time as US economic data has missed expectations. But could this turn around? If the data has been weak, surely this means expectations will be lowered, and thus easier to beat? NFP’s for February are expected to come in at 150k, last month the market had expected 180k, so may be the goal posts are shifting? If data does start to pick up, regardless of whether or not expectations are lowered, it could trigger a broad-based reversal in the USD.
What does this mean for traders?
• If we get further data misses this week, especially NFP, watch the S&P 500. It could struggle to break fresh record territory, if the economic fundamentals are too flimsy to back it up, and we could see a bout of profit taking knocking it back from recent record highs.
• However, since the S&P 500 has been rising as data has missed expectations, if NFPs are stronger than expected, we may not see a sharp increase in stocks as the good news may already be priced in.
• The dollar could be the larger beneficiary if the data starts to pick up, as it has come under downward pressure at the same time as US data has missed expectations.
Takeaway:
Overall, we are at a critical time for stocks, the dollar and US economic data. The next few days could be crucial for the future direction of markets and may help us to break out of some frustrating ranges for major FX pairs. Friday’s Non-Farm payrolls report could be even more important than usual.
Figure 1:
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