July Fed Minutes released on Wednesday hit risk appetite despite lack of clear hawkish shift in the tone of wordings. Markets saw renewed selling pressure albeit with more vigor thanks to synergy of selling catalysts – lackluster July US retail sales, growing hawkish bias of the Fed, growing dollar’s appeal as ultimate safe heaven, as well as seasonal weakness. Amid a surge of risk-off, greenback index soared to a 10-month high (93.50 level in DXY).

Small-cap and value stocks led declines with Russell 2000 futures falling 1.7% at the time of writing and European equity indices, populated mostly by value stocks, erasing 2% on average. SPX futures tanked 1% today, extending 1% loss of S&P 500 during NY session on Wednesday. There is a clear market bias to short stocks which upside is positively correlated with expectations of economic recovery suggesting a repricing of economic growth prospects is underway. This bodes ill for potential depth of the current decline which may be the first serious market pullback after series of short-term dips earlier in the year whose depth was less than 5%.

Minutes of the July FOMC meeting showed that officials did discuss QE, but their opinions were divided over when to start phasing out stimulus. Some officials proposed to start this fall, others - at the beginning of next year. Nevertheless, the very fact that QE end is in sight and higher prospective interest rates on bonds will induce major equity-bond rotation dampened the mood in equities. After a brief upside bounce on the release of the Minutes, S&P 500 turned into decline:

But what’s really disturbing is that the Fed’s tapering story unfolds around the same time as US data started to show signs of fading growth momentum. Weak retail sales in July and consumer sentiment in August put a major dent on recovery hopes. There may be growing concern among investors that August data will extend the streak of downbeat US data surprises, which greatly adds to risk-off and makes current valuations fragile.

Today there will be data on applications for unemployment benefits, which can somewhat ease bearish pressure if it shows that positive labor market trend remains intact. In addition, markets will watch on the Philadelphia Fed Business Outlook to see if US businesses are starting to feel any weakness of the economy.

Considering DXY positioning, it can be seen that price made decisive breach of the upper line of the pattern:

The previous idea of a false breakout appears to be defied by the latest price action as DXY has been given powerful boost by flagging support in equity which induced safe-haven flows. The prospects of further decline also imply additional upside potential of the US currency with EURUSD’s next closest target at 1.16 level.