Is the market pricing in US economic weakness ahead?

There have been some notable movements in the cross markets in the last few weeks that, to me, signal a shift in the posture of what the market is pricing in with regards to growth in the US. They were correlations in the movement of the USD and US equity markets which have been trending lower on an intermediate time frame. I've included a chart to show the movements of some major asset classes for the past year below.

On the charts I've shown two arrows (click on the chart for a larger view). The first yellow arrow and the text that goes with it indicates when the USD started to move higher along with the equity markets. Prior to this point the USD had been steadily trending lower from the highs achieved during the worst of the GFC, as the USD is seen as a safe haven currency when risk aversion is high. Thus when global stock markets rallied in March of 09, risk appetite was back and so investors began to sell out of the USD. However a strange thing occurred in late November of 2009 when the USD started to rally along with the US equity markets. This was probably due to the stronger than expected economic data points coming out of the housing and unemployment numbers that signalled the US economy was now showing relative economic strength compared to the rest of world and so investors reallocated more capital to US denominated assets. (See this link to the forexfactory econ calendar to see just what the numbers were http://www.forexfactory.com/calendar.php?month=12&year=2009

From this it would be safe to hypothesize that the strength of a country's currency is a direct proxy for the strength of its economy. Therefore, the stronger the economy the stronger its currency. As someone that has studied finance, this is a generally accepted theory. What's concerning to global equity bulls of late is that the USD has sold off at the same time as the equity markets have sold off. No more of this flight to safety trade that we witnessed throughout the GFC where investors would sell equities and then buy US government treasuries, and indirectly the USD. I've highlighted with a red arrow when this took place and the possible weaker than expected economic data points for it. (See this link to the forexfactory econ calendar to see just what the numbers were http://www.forexfactory.com/calendar.phpc=2&week=1275177600&do=displayweek&month=6&year=2010

There are two things to take away from this. One is that the market is pricing in weaker US economic growth relative to the world (note that the Euro has rebounded quite significantly off its lows in recent weeks) and the other is that the normal machinations of global markets is in order as we starting to diverge away from the whole risk on/ risk off trade where everyone would run for the most liquid financial assets (usually USD's & Yen) at the first sign of financial market weakness. To me that's a positive sign because its shows that there is less fear and the market is probably not pricing in a double dip recession (just yet??).

With the unexpected weakness in the economic data however, we have seen a sharp rise in the price of bonds as indicated by the TLT indicating that bonds and not equities has probably become the dominant investment decision of investors and institutions alike. The other notable movement 2 weeks ago was to see gold come off it's highs moving lower along with the USD and the stock market. It's generally accepted that gold is seen as a store of value in times of uncertainty and as an inflation hedge. Perhaps the movement of late is indicating that while there is still a whole lot of uncertainty out there, the latter reason (inflation) is becoming less and less of a reason to buy gold (ie that deflationary forces are winning out). Certainly the movement in the bond market would seem to confirm that. Maybe global markets are heading for the Japanese style "lost decade" type of market where deflation still rules and the long term return of equity markets have gone basically nowhere, characterized by increased market volatility with impressive rallies and sell offs. Something to think about.........