The world is a funny old place
Where confidence in growth’s fast pace
Is what undermines
The positive signs
In stocks and bonds, causing retrace (ment)
“My personal outlook for the economy has strengthened since December. We’ve seen continuing strength in the labor market. We’ve seen some data that will, in my case, add some confidence to my view that inflation is moving up to target. We’ve also seen continued strength around the globe, and we’ve seen fiscal policy become more stimulative.” So said Jerome Powell to the House Financial Services Committee yesterday morning when answering a question specifically about the number of rate hikes the Fed may implement this year. And the market response was immediate, with both stock and bond prices falling sharply while the dollar rose on this ‘hawkish’ reply.
One cannot be surprised at this market reaction. We have spent the past several years in the ‘Goldilocks’ economy, where growth has been solid but inflation absent thus allowing the Fed, and truly most central banks around the world, to leave excessive monetary accommodation in the system. The result has been remarkably low interest rates for an economy growing reasonably well, and a boon to both equity and fixed income markets. But all good things must come to an end, and with the uber-dove Janet Yellen no longer occupying the Chairmanship, it was inevitable that this would occur.
My take on Chairman Powell’s testimony is that he is not likely to attempt to obfuscate his views in the manner of the more recent Fed Chairs. I believe he knowingly personalized his testimony, discussing his own views rather than the committees, and that his more forthright manner is likely to be welcomed by investors over time. But my view is likely a minority one. The evolution of policy under both Bernanke and Yellen had been such that they appeared overly sensitive to market movements. In other words, if either of them said something that upset the market’s ‘demand’ for continuing Fed largesse and resulted in a sharp decline in the stock market especially, Fed speakers were on the tape within hours to walk back the comments. I foresee much less of this behavior going forward. Instead, my sense is that markets will simply have to evaluate the data and adjust accordingly. Personally I see this as a healthy and long overdue change to policymaking. It is likely to increase the volatility in markets somewhat, especially since Powell is alone in this attitude. After all, the other main central banks continue under their previous leadership, so it is unlikely that either Signor Draghi or Kuroda-san are about to change their style. In the end, this is merely one more reason that I like the dollar to rebound as the year progresses.
But let’s look at the things impacting the dollar today. The buck is broadly stronger (EUR -0.1%, GBP -0.7%, JPY +0.3%) after not only the perceived hawkishness from Mr. Powell, but also from a swath of weaker than expected economic data from around the world. Chinese PMI data printed at its weakest level in nearly two years at 50.3. While there was no doubt that the Lunar New Year celebration had some impact, the underlying indices showed very consistent weakness. We also saw weakness in Japanese Construction Orders and Housing Starts to close out the Asia session.
European data then followed this trend with weaker than expected Finnish GDP (0.7%); German GfK Confidence (10.8); French inflation (1.4%); and Italian Inflation (0.7%); and that was after a weaker than expected German Inflation print yesterday (1.2%). The continuing lackluster inflation data remains Draghi’s driving impetus in his efforts to prevent the market from assuming the end of QE. So when the ECB meets at the end of next week, the latest set of data will show still limited progress on inflation, especially in the big three economies of Germany, France and Italy, and will allow the doves to continue to control the message. As I have consistently maintained, the market continues to underestimate coming Fed aggressiveness (although that is changing after Powell yesterday) and overestimate the probability that the ECB is going to tighten policy soon. Eurozone data from yesterday and today simply highlight my case and this is the crux of my argument that the dollar will rebound.
This morning brings a reprieve on the Powell front, with the Chair waiting until tomorrow to address the Senate. However, we get the second reading of Q4 GDP, originally showing growth of 2.6%, but forecast to decline to 2.5%. That adjustment appears to reflect expectations that Real Consumer Spending in Q4 was actually a touch lower at 3.7% (originally released at 3.8%). We also see Chicago PMI (exp 65.0), which would be a modest decline from last month, but still at nearly the highest levels since the late 80’s. In other words, it seems unlikely that the Chairman’s bullish view on the US economy is going to be called into question today. Ultimately, I continue to see the trajectory of US interest rates higher at a faster pace than elsewhere in the world, and I continue to see the dollar benefitting. Hedgers, keep that in mind.