Said President Trump ‘bout the buck
Though Stevie said weakness don’t suck
In truth I believe
That what you perceive
Is really I don’t give a f*ck
Who said volatility is dead? Yesterday’s price action in the FX markets was as volatile as we have seen since, arguably, the GBP flash crash in October 2016. The market was still trying to come to grips with an apparent change of policy by the US, where the decades old mantra of ‘a strong dollar is good for the US’ had been unquestioned by both traders and every Administration and has now been called into question by the current Administration. Or at least that seemed to be the case for about twenty-four hours before President Trump, in a CNBC interview, pledged fealty to the strong dollar idea saying,“…the dollar is going to get stronger and stronger, and ultimately I want to see a strong dollar.” It should be no surprise that the dollar rallied after those comments and regained the bulk of the Mnuchin inspired losses.
But that wasn’t the only thing that happened yesterday. If you recall, the ECB met and we heard from Signor Draghi afterwards. To start, the ECB statement was identical with the December statement, so for the euro bulls, that was a bit disappointing. There was no change to the language regarding the end of QE nor when interest rates might start to rise. But during the press conference, aside from Draghi calling out Mnuchin’s comments as impolitic, he did nothing to dissuade the euro bulls from their view that QE is going to end in September and that at the March meeting Draghi will be discussing changes to their strategy. And so despite all the sturm und drang, the euro’s rally continues apace with the single currency rallying 0.55% from yesterday’s closing levels.
Meanwhile, market technicians are becoming extremely excited by the movement as the dollar has fallen below several key technical levels and, according to that group, is set to extend its losses more aggressively. And maybe they’re right, but remember this, none of this activity occurs in a vacuum. The US economy continues to show substantial strength, and we need only see slightly higher than expected inflation readings to force the Fed’s hand into more aggressive tightening than currently forecast. And if there’s one thing about which I am confident, it is that if the Fed starts to get more aggressive, the dollar will find its footing. Interest rate markets continue to price just less than two Fed rate hikes in at this time. The Fed itself expects three and an increase in inflation readings could easily push that to four or five. Remember, it is not a requirement that the Fed only adjusts rates at a meeting with a press conference; they can do so at any time, even with no scheduled meeting if they deem it appropriate. Higher and rising inflation will be the one issue that takes them out of their comfort zone, and I continue to believe that is a very realistic outcome. After all, as I ask frequently, do you feel like your personal inflation rate is 1.5%? I know mine isn’t!
And that was really the story yesterday and overnight. Today brings President Trump’s speech at Davos, scheduled for 8:00 EST and then some important data, notably the first look at Q4 GDP (exp 2.9%) and Durable Goods (exp 0.6%, -ex transport 0.6%). Strength in these data points will only serve to underpin the Fed’s current trajectory. My sense is that Monday’s PCE data will also be very important, given the Fed’s focus on that data as the inflation measure that fits their models. So any uptick relative to expectations there could have much more significant market ramifications.
In the end, my sense is the Goldilocks story for markets is nearing its end. One of its defining characteristics has been the remarkable lack of volatility across all markets, but now we are beginning to see that change. Clearly, yesterday’s FX volatility was driven by exogenous sources, but in many ways, that doesn’t really matter. If volatility turns higher in a more lasting manner, be prepared for it to extend to all markets. And remember this, volatility in equity markets has become a euphemism for falling stock prices, so higher volatility is likely to matter to us all.
Good luck and good weekend