Truly a Mystery

December Rate Hike Probabilities:

USD   76.7% = (The Minutes should help confirm)

EUR     3.6% (Think December 2019)

GBP   81.0% (Done deal, probably in November)

CAD   59.2% (Not as confident as before)

Fed Rhetoric               25bps


Like any religious consistory

The FOMC looks at history

Though it can’t explain

Why prices remain

So stable, it’s truly a mystery!


In the wake of the FOMC minutes released yesterday afternoon, and ahead of Friday’s CPI release, the dollar has taken a breather overnight, showing very little net movement. While that broad stability masks some individual movement, the big picture remains of a dollar that appears to have halted its year-long slide, but is not ready yet to accelerate higher.


A quick look at the Minutes showed that the Fed’s models are still not doing a very good job in forecasting inflation. The hawks continue to discuss one-off idiosyncrasies, like the decline in cell-phone data charges as a possible hindrance to higher inflation. The doves are coming round to the idea that the inability of wages to rise is a result of the increasing global supply of labor.   In other words, they have no idea why prices are behaving as they are, and are throwing every idea they can against the wall to see which one sticks. The one thing that seems clear, however, is that they will not be deterred from raising rates again in December unless the interim data takes a significant turn for the worse. And given the uncertain impact of the hurricanes on that data, it seems that they will be able to look through any weakness as merely another transitory factor. However, having said all this, it appears that the market’s interpretation of the Minutes was far more dovish than mine, hence the dollar’s late afternoon sell-off.


It is fair, however, to ask if the three rate hikes for next year that the FOMC have, themselves, penciled in are going to see the light of day. I continue to believe that one of the key reasons they are so anxious to raise rates is to have room to cut them when the next downturn arrives, although they cannot actually admit that. My point is that we will need to see extremely weak data in order to derail that plan, and as of now, there is no indication that will be the case. One other thing to keep in mind is that we are fast approaching the announcement of the next Fed Chair, and I keep reading that Kevin Warsh is the front-runner. He is decidedly more hawkish than Ms. Yellen, and would almost certainly seek to push rates higher still. Of course, all of this matters to us in FX because of the current dollar narrative, which despite all evidence to the contrary, continues to assume that the Fed will be less hawkish than their rhetoric and the ECB and BOE more hawkish. Nothing in these Minutes has changed my view that the narrative is wrong and will change with the dollar benefitting over time.


The other story of note this morning is the ongoing angst in the UK over the progress, or lack thereof, in the Brexit negotiations. The latest round of talks, which are due to end this week, have produced nothing of note and it appears that both sides are waiting for the other to crack on something. If forced to handicap this outcome, I am leaning toward a hard Brexit with no transitional deal. Ultimately, the biggest sticking point is going to be money, and the EU is going to continue to insist that the UK owes an astronomical number, which I bet will grow to be €100 billion before the talks are done. At the same time, the UK is going to insist that without a transitional agreement, there will be no payment, and even with one, the number is in the €20 billion range. That’s a pretty big gulf to overcome, and based on the ongoing dysfunction within PM May’s government, I just don’t see a resolution. No matter the long-term potential benefit for the UK to regain its sovereignty, the near term is going to be messy, and the pound is going to suffer. Folks, above 1.30 the pound remains a screaming sale in my view. Ironically, as I was typing this, the pound just fell 50 pips on this BBG headline “*GBP/USD FALLS TO 1.3170; BARNIER SAYS DEADLOCK IN BREXIT TALKS”


Looking elsewhere, the yen continues to edge ever so slightly higher on the back of a series of polls showing that PM Abe is set to win a resounding victory in the upcoming Japanese elections with a chance to capture a two-thirds majority of the lower house, enough to make constitutional changes. The Nikkei has been performing well while the yen has arrested its month-long decline and found a new stability. In the commodity bloc, both AUD and NZD are firmer by about 0.5% this morning as a result of renewed Japanese investor buying of both currencies.


Meanwhile, in the EMG bloc, amid a session with an equal number of gainers and losers, no currency has moved more than 0.3%, and there are no stories of note to reflect.


This morning brings the first real hard data of the week, PPI (exp 0.4%, 0.2% ex food & energy) as well as Initial Claims (250K). The thing is the FX market doesn’t typically pay close attention to PPI, especially with CPI to be released tomorrow morning, and the Initial Claims data continues to be roiled by the aftermath of the hurricanes last month. As such, I don’t see either one having a substantive impact on the FX markets today. That leaves us with Central bank speakers as the most likely catalyst for movement today. It seems the bulk of them are in Washington for the annual IMF and World Bank meetings with Powell and Brainard from the Fed on the schedule as well as Draghi, and we will also hear from Germany’s outgoing FinMin, Wolfgang Schaeuble. While I don’t anticipate too much new news, one can never be sure in these circumstances.


Net, I don’t anticipate much movement overall today, but if I had to guess, the dollar’s corrective fall is likely close to an end.


Good luck