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Global Macro: Economic Data Back Up Fed

Stocks in this article: MDY OEF EWG SPY UUP

NEW YORK ( TheStreet) -- Tuesday's economic data backed the Federal Reserve's announcement last week that it may slow bond purchases if the economy strengthens as durable goods orders and existing home sales outperformed expectations. Alongside support from the People's Bank of China, global markets rebounded and riskier assets found buyers.

The first chart below is of SPDR S&P MidCap 400 (MDY) over iShares S&P Index (OEF), which measures strength of mid-cap stocks relative to large caps in the S&P 500. As smaller-cap stocks outperform larger ones, represented by upward price movement in the chart below, investor sentiment tends to be strong.

Since mid-May, this pair has trended lower, signaling that investors were favoring large-cap stocks and positioning portfolios defensively. The Fed's announcement last week brought this pair down to yearly lows.

As markets have stabilized, realizing that dire predictions of market weakness may be overstated, the price action has rebounded higher.

Many equity investors waited on the sidelines looking for more clarity about U.S. monetary policy and for a pullback after a long run-up in equities. Now, after the pullback, those investors are looking to be put money back in the markets.

The next chart is of SPDR S&P 500 (SPY) over iShares MSCI Germany Index (EWG), which measures the relative strength of U.S. equities versus German equities. Germany is perceived as the strongest European economy and thus is a good indicator of strength in the more industrial economies of Europe.

The U.S. economy showed more improvement than European economies through much of 2013. That led to U.S. equities outperforming their European counterparts and to a stronger dollar versus euro. The pair below correlates strongly to movements in the euro/dollar currency cross and is thus a good predictor of currency market movements.

As U.S. monetary policy came into question in late April/early May, this trend began to reverse. The U.S. dollar weakened and European assets, led by the German economy, began to outperform world equity markets.

The chart's price action this year has boiled down to economic outlook and clarity of central bank policy. The Fed's explicit plan for monetary tightening signaled U.S. dollar strength over the long term.

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