DAILY STRATEGY: Main Point – Gold, 10yr yields, breakeven inflation rates send a signal on where inflation is headed. Equities, the shape of the yield curve, and credit spreads send a signal on how. Conflating the first layer with a soft-landing assumption is where the analytical error could creep in. We have high conviction on the destination (lower inflation to respect an economic speed limit of 2%), but lower conviction on how we get there. Our bias is weaker growth in the back half of 2026 lowers inflation the “easier way”. Call that a 6 out of 10 conviction.
Easy vs. Hard Way to Lower Inflation – The hard to lower inflation would be Fed hikes to slow GDP growth. Recession probabilities go up in this scenario and stocks have downside risk. The easier way is core inflation slowing over the back half of 2026 toward the Fed forecast of 3.3% YoY or below as GDP growth slows following the 1H26 boost from Fiscal. The Fed remains on hold as growth and eventually inflation moves lower. Odds of extending the economic cycle increase in this scenario and markets would be biased higher. In both scenarios expect Inflation expectations, gold, and 10yr yields to be biased lower and the USD higher. The question is HOW inflation slows back toward the Fed’s target.
USD INFLUENCE ON RETURNS: We got a few questions yesterday on the Dollar’s influence on stocks generally and on Momentum specifically.
Investors will look through noise, but the current move in the USD does clear the historical threshold at which the USD tends to influence returns. Based on the historical beta to the USD, the threshold for weekly Dollar moves that matters is ~125bps. The current move is 150bps.
A higher USD is a headwind to equities in 2 ways. 1) Via tighter financial conditions. Gerard attributes the currency move to rate differentials (HERE). The USD and short rates are still trending together. US 2yr yields are increasing relative to the rest of the world, supporting the USD and tightening FCI at the margin. For now, 10yr yields declining offset the USD strength. Credit spreads remain tight. If the US 2yr yield surges toward 5%, it is likely the USD impact on financial conditions, along with other inputs, would become more intense.
2) Via a headwind to earnings. We put together a simple model that suggests a 1% increase in the trade-weighted Dollar takes away roughly 25bps from EPS growth. Don’t get wedded to false precision here — direction and ballpark magnitude matter more than exact numbers.
The USD screens as the macro variable with the largest impact on Price Momentum historically, but Price Momentum’s rolling beta to the USD is too unstable to draw a conclusion with any conviction. Rather than lean on the unstable historical data, we can consider the current situation. If the USD has a sustained move higher, it’s likely to be in response to hot inflation data and higher rates. Warsh made it clear that price stability is a priority. IF core inflation is too high (>21bps a month from here through the end of the year), then there could be a VAR shock/broad derisking. In that, Momentum will lead to the downside (definitionally). Financial conditions tightening is a live risk, adding to Momentum vol right now.
FYI, idio risk (AI) is still highly influential over Momentum returns too. Micron overnight will help.
Charts…
We estimate SPX sensitivity to the broad Fed trade-weighted index using post-2020 weekly returns. Rather than a single unconditional beta, we test whether the USD/equity relationship is meaningful beyond a minimum move size, running separate regressions above and below a grid of move thresholds. USD moves below 0.50% are statistically indistinguishable from noise. Beta scales above 1.25%. We find meaningful asymmetry: USD strength carries roughly 2.4x the impact of equivalent USD weakness.
Source: Bloomberg, 22V Research, Modeling done with Claude
The Dollar is tracking the rate differential between the US and the rest of the world. We are hesitant to abandon that framework after 1 day or divergence.
We put together a simple model that suggests a 1% move in the trade-weighted Dollar adds/subtracts roughly 25bps to EPS growth. The recent 150bp appreciation in the Dollar subtracts roughly 37bps from EPS, were it to hold. Don’t get carried away with the false precision here — direction and ballpark magnitude matter more than exact numbers. We’re happy to provide more details on the model if helpful.
The USD has the largest effect on Momentum returns across macro variables, but as the line chart shows, Momentum beta to the Dollar is volatile. We are more likely to be right about the current influence of the Dollar on Momentum by focusing on inflation and financial conditions.
Source: Bloomberg, 22V Research
The Dollar has the largest impact on risk factors right now, consistent with the idea that financial conditions are the main channel the USD is operating through.
