The market was still immersed in the optimistic atmosphere of the "Trump trade" just a moment ago, but volatility began to soar from Wednesday (17th) this week. Major US technology stocks plummeted, and the US dollar index also broke downward.

The Nasdaq index fell by 2.8% on Wednesday, marking the largest single-day drop since December 2022. AI concept stocks, which have dominated the past two years, suffered a Waterloo, and comments by US presidential candidate Trump on the chip industry and geopolitics directly led to a sharp 8% drop in TSMC's stock price that day. What the market fears even more is that if Trump were to return to the White House, protectionist policies could bring a more lasting impact on large technology stocks.

Generally speaking, a strong US dollar could lead to a counter-trend in the stock market, but on the same day, the US dollar index also fell sharply, breaking through the important support level of the 200-day moving average, heading towards the 103 mark. This is mainly related to the significantly increased expectations for a rate cut in September. Several traders and strategists interviewed by Yicai believe that the US dollar index may have reached a phase peak, but the impact on the renminbi is more complex.

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Liu Yang, a senior foreign exchange expert and general manager of the financial market business department of Zhejiang Zhongshang Group, told reporters: "The next support level for the US dollar index is at the 103 integer level, which roughly corresponds to the 1.10 mark for the euro/dollar and the 120-day moving average for the dollar/yen. Trump said in an interview, 'The yen and the renminbi are too cheap,' and the yen rose accordingly, which should be the result of carry trade reduction and trampling. The renminbi is likely to fluctuate sideways in the near future, and it is necessary to observe the willingness and pace of exporters to exchange currency."

"Trump trade" drives style rotation

After two months of calm, market volatility has suddenly increased, and style rotation has intensified.

Comments by Trump on the chip industry and geopolitics during the interview directly led to a sharp drop in TSMC's stock price. What is more worrying is that US President Biden is also considering upgrading high-tech export restrictions. The Nasdaq index fell by 2.8% on Wednesday, the largest single-day drop since December 2022, and the S&P 500 fell by 1.4%. The VIX index of panic jumped to a six-week high, and the potential impact of the US election is gradually emerging.

"Fortunately, the market's optimistic sentiment has not completely reversed, and the style shift has allowed the Dow Jones index to continue to set new historical highs. It's just that the continued decline of heavyweight stocks after the market hours makes investors worry whether the Dow can get through this stage," Jerry Chen, a senior analyst at Gain Capital Group, told reporters.

Although US stocks have plummeted, this is not due to a reversal of interest rate cut expectations, but more due to the fluctuations caused by style switching. Currently, the interest rate cut in September is almost a foregone conclusion, and the US dollar index has also broken through the 104 mark. At the beginning of this week, the combination of interest rate cut expectations and "Trump 2.0" continued to shift market focus from a few large technology stocks to a broader range of cyclical stocks and small and medium-sized stocks. The Dow Jones index rose by 1.9% on Tuesday (16th), closing close to 41,000 points to set a new historical high. The Russell 2000 index rose by more than 3% overnight, and all five trading days in the past have risen, with a cumulative increase of 11%. In contrast, the gains of the S&P 500 and Nasdaq indexes are significantly lagging.

After a cumulative increase of 20% this year, the Nasdaq 100 index began to encounter a "crisis of trust". The US's protectionist policy tendencies and presidential candidate remarks have caused the already extremely crowded and overbought index to loosen. "The uptrend line from April to now forms an important watershed near 19,700 points. If it breaks, it may fall to below 19,300 points or even 19,000 points. The last two significant pullbacks of the index were -12% from July to October last year and -8% from March to April this year," Chen told reporters.Will geopolitical risk factors replace the expectation of rate cuts as the dominant force in the US stock market? Institutions generally believe that it may not, and investors may just use the cover of Trump and Biden's policy speeches to take profits and adjust their positions. But the financial reports released in the next two weeks will test the profitability of star technology stocks and will indicate the direction of the Nasdaq's trend. The US dollar index may peak in stages As multiple economic data gradually weaken, the expectation of rate cuts in September remains above 90%. The US dollar index has recently shown signs of peaking. Eric Robertsen, global chief strategist at Standard Chartered, told reporters that the US CPI data released on July 11 was lower than expected, the PMI data in June fell, and the latest employment data softened. These economic data confirm the fact that the US economy has finally slowed down after ignoring the expectation of deceleration for most of 2024. Currently, the manufacturing and service PMI indexes are both below 50, and the unemployment rate has exceeded 4% for the first time since January 2021. The Atlanta Fed GDPNow model predicts that GDP growth has fallen below 2% in the current quarter. "We expect the Fed to start its first rate cut of 25BP in September. The outperformance of the US economy is a recurring theme in 2024, but recent data show that the growth gap between the US and other economies will narrow in the coming months." Robertson said. Fed Chairman Powell recently said that he is more confident that inflation is falling towards the Fed's 2% target. After his speech, the market now believes that the probability of the Fed's rate cut in September has reached 100%. Starting this week, the Fed is also using its last week of comments before the start of its media silent period. Christopher Waller, a voting member of the FOMC who is considered a hawkish member, said that the Fed is closer to cutting interest rates, but has not yet reached this point, and he is optimistic about the continued easing of inflation. Richmond Fed President Thomas Barkin said that he is sure that the Fed will discuss whether it is appropriate to describe inflation as "high" at the next meeting. Although he added that a 25BP rate cut will not change much, it is more about deciding when the Fed's narrative needs to be changed. The dollar index fell below the 104 mark on July 18, breaking through the key 200-day moving average support level, which traders believe is far-reaching. The euro extended its gains against the dollar to 1.0939, and the pound rose to 1.3 against the dollar, a one-year high, under the influence of the UK's higher-than-expected CPI data. Risk aversion helped the yen and Swiss franc exchange rates rise sharply. "The Japanese Ministry of Finance (MOF) seems to have taken full advantage of the path of least resistance, that is, intervening when the Fed turns dovish. It looks like the MOF intervened again on Wednesday, causing the yen to appreciate generally against all major currencies except the Swiss franc. "said Jerry Chen. As of 18:00 Beijing time on July 18, USD/JPY had fallen to around 156, having previously broken through the 162 mark. The yen's trend currently seems to be stabilizing, but shorts may enter the market when it rebounds to 157 in the hope of falling to the 154 mark. Liu Yang told reporters: "Trump's remarks directly pushed the yen to strengthen and the dollar to weaken. 162 may be the bottom of this round of yen depreciation against the dollar. The US dollar index has not been able to stabilize at 104. Short sellers may enter the market when there is a small rebound, with the target being the June low, which is the 103 integer mark." The RMB may fluctuate sideways after stabilizingUnder the backdrop of the strong US dollar reaching its peak, the Chinese yuan has noticeably begun to stabilize in the past two weeks. Previously, the US dollar against the offshore yuan once broke through 7.3, and as of 18:00 on July 18, Beijing time, the US dollar/ offshore yuan was quoted at 7.2728, and the US dollar/ yuan was quoted at 7.2597.

Robertson stated that in recent quarters, the economic cycles of China and the United States have shown significant differences. Since 2021, the widening interest rate differential between China and the US has kept the US dollar/ offshore yuan exchange rate close to a ten-year high. "A slowdown in the US economy in the coming months may help narrow the interest rate differential between the two countries, which may in turn help alleviate the depreciation pressure on the offshore yuan."

Nevertheless, the yuan still faces internal and external pressures, and industry insiders tend to believe that the yuan will maintain a sideways fluctuation against the US dollar. In terms of economic fundamentals, the economic data for the first half of the year released this week shows that China's GDP growth slowed from a year-on-year increase of 5.3% in the first quarter to 4.7% in the second quarter. Retail data decreased from a year-on-year increase of 3.7% in May to 2.0% in June, indicating that domestic demand still needs to be stimulated. However, exports are strong, with the year-on-year growth rate of exports in June accelerating from 7.6% to 8.6%, which is stronger than the market's expectation of 8%.

In addition, there is still uncertainty about the narrowing trend of the China-US interest rate differential. Barclays still predicts that the yield on US 10-year Treasury bonds will rise to 4.5% by the end of the year (currently around 4.2%). If the US economic growth slows down significantly, the yield on US Treasury bonds may decrease, but Barclays believes that this situation is unlikely to occur. The reason is that the extent of US interest rate cuts may be limited, and the rising probability of Trump taking office has also increased the expectation of an expansion of the US fiscal deficit, which may lead to an increase rather than a decrease in Treasury bond yields.

The foreign exchange market may still face uncertainties brought by geopolitical factors. "One point that some market participants are increasingly worried about is that if Trump wins the election, trade frictions may intensify. Nevertheless, the volatility of Asian currency exchange rates has not risen to higher levels. The 3-month volatility of the US dollar/ offshore yuan exchange rate and the US dollar/ Singapore dollar exchange rate is still below 4%, and the 3-month implied volatility of the US dollar/ Indian rupee exchange rate is below 2.5%. Once global trade tensions escalate, if the foreign exchange market cannot play the role of a pressure relief valve, gold may serve as another alternative choice." Robertson said.

Looking ahead to the second half of the year, Li Xiaoming, a foreign exchange trader at the Bank of Communications' financial market department, believes that the yuan foreign exchange market may exhibit the following characteristics: First, the volatility is expected to rebound from a low level. Taking the 1-month period as an example, the historical volatility of the yuan exchange rate in the first half of the year approached the lowest level since 2015. Driven by market transactions, the force for the yuan's volatility to return to the central value is gradually accumulating. The elasticity of the yuan exchange rate in the second half of the year may increase, which will also help to suppress carry trade. Second, the central parity rate and the spot exchange rate are expected to converge. Recently, the central parity rate has continued to depreciate moderately and set a new low for 7 and a half months, reflecting that the regulatory authorities are steadily releasing pressure and are conducive to further leveraging the regulatory role of the market. Third, seasonal factors will gradually fade away. From June to August each year, driven by seasonal foreign exchange purchase demands such as dividends and interest payments from Chinese companies listed overseas, profit remittances from foreign companies, and residents' summer travel abroad, the yuan often shows a phased depreciation trend. After the end of seasonal foreign exchange purchases, it is expected that the yuan exchange rate will strengthen slightly in the fourth quarter.