Macro-quantamental factors
Central banks regularly adjust the economy’s monetary base through foreign exchange interventions and open market operations. Point-in-time information on such intervention-based liquidity expansion has predictive power for asset returns. That is because such operations often come in longer-term trends, and there are lagged effects, for example, through private sector portfolio rebalancing.
Alas, the discovery of the economic value of intervention-liquidity signals is often obscured by “ugly backtests”: as a single type of information applied to a single asset type, simulations typically show patchy relevance and uneven value profiles. However, across strategy types and asset classes, intervention-driven liquidity growth has consistently contributed value. A simulation combining two directional and two relative-value strategies demonstrates steady and meaningful PnL generation with low correlation to major market benchmarks.
There are plausible relations between past and future short-term trends across and within financial markets. This is because market returns affect expected physical payoffs, risk premia, and the monetary policy outlook. However, the relations between past and future returns are unstable and often depend on the economic environment.
As an example, this post shows that the impact of short-term commodity future trends on subsequent S&P500 future returns depends on the inflationary pressure in the U.S. economy. Empirical analysis suggests that macro-conditional trend signals outperform unconditional short-term trend signals regarding predictive power, accuracy and naïve PnL generations.
Bank lending surveys help predict the relative performance of equity and duration positions. Signals of strengthening credit demand and easing lending conditions favor a stronger economy and expanding leverage, benefiting equity positions. Signs of deteriorating credit demand and tightening credit supply bode for a weaker economy and more accommodative monetary policy, benefiting long-duration positions.
Empirical evidence for developed markets strongly supports these propositions. Since 2000, bank survey scores have been a significant predictor of equity versus duration returns. They helped create uncorrelated returns in both asset classes, as well as for a relative asset class book.
Local-currency import growth is a widely underestimated and important indicator of trends in fixed-income markets. Its predictive power reflects its alignment with economic trends that matter for monetary policy: domestic demand, inflation, and effective currency dynamics.
Empirical evidence confirms that import growth has significantly predicted outright duration returns, curve position returns, and cross-currency relative duration returns over the past 22 years. A composite import score would have added considerable economic value to a duration portfolio through timing directional exposure, positioning along the curve, and cross-country allocations.
Excess inflation means consumer price trends over and above the inflation target. In a credible inflation targeting regime, positive excess inflation skews the balance of risks of monetary policy towards tightening. An inflation shortfall tips the risk balance towards easing. Assuming that these shifting balances are not always fully priced by the market, excess inflation in a local currency area should negatively predict local rates market and equity market returns, and positively local-currency FX returns.
Indeed, these hypotheses are strongly supported by empirical evidence for 10 developed markets since 2000. For fixed income and FX excess inflation has not just been a directional but also a relative cross-country trading signal. The deployment of excess inflation as a trading signal across asset classes has added notable economic value.
Employment growth is an important and underestimated macro factor of financial market trends. Since the expansion of jobs relative to the workforce is indicative of changes in slack or tightness in an economy it serves as a predictor of monetary policy and cost pressure. High employment growth is therefore a natural headwind for equity markets. Similarly, the expansion of jobs in one country relative to another is indicative of relative monetary tightening and economic performance. High relative employment growth is therefore a tailwind for the local currency.
These propositions are strongly supported by empirical evidence. Employment growth-based trading signals would have added significant value to directional equity and FX trading strategies since 2000.