This afternoon promptly at two
The Fed will release for review
Details from last meeting
(Will they soon be Tweeting?)
Where traders search for the next clue
Will these Minutes lead us to think
The FOMC’s on the brink
Of changing their pace
And now their base case
Is four rate hikes while assets shrink?
The dollar continues to hold its own this week, edging higher yet again as the euphoria surrounding the Eurozone’s economic growth was dented by slightly disappointing PMI data at the same time that US interest rates continue to creep higher. Starting with the Eurozone, Flash PMI data was released with a resounding thud. Even though the data was pretty strong (Manufacturing 58.5, Services 56.7, Composite 57.5), all three releases were a full point beneath expectations. So as we have seen numerous times, it seems that the economists may be getting slightly ahead of themselves in their forecasts for economic growth, extrapolating trends that are now flattening. Don’t get me wrong, compared to what the Eurozone was doing just one year ago, this data is great, and still points to Q1 GDP growth of 0.8%, its just that the market was pricing in even more. In the end, traders have continued their recent sales of euros with the single currency down a further 0.2% this morning.
We also saw UK data, in this case on employment, which showed that wages were improving, rising 2.5% in January, and the claimant count fell, but that the growth in employment has moderated. It is also key to remember that CPI in the UK is running at 3.0%, so real wages continue to decline there. The market remains convinced that the BOE is going to raise rates in May, but I continue to be skeptical of that outcome. Given the ongoing uncertainty regarding the Brexit situation and how it will ultimately impact the UK economy, it seems unlikely to me that the BOE will want to tighten policy and find themselves having made a mistake because of a downturn. Net, the pound, too, has fallen this morning, and is lower by a pretty healthy 0.55% as I type.
But the reality is that the talk of the markets continues to be biased toward central bank activities and their evolution. This afternoon the Fed releases the Minutes of their January meeting. If you recall, the big news from that meeting was the addition of the word ‘further’ in their description of raising rates this year. In fact, since that meeting, based on the data we have seen showing increased inflation pressures, the market has adjusted its expectations for the number of rate hikes coming. Economists are now looking for four hikes, and even the futures market has a 20% probability priced in for four hikes. Remember, it was less than a month ago when the futures market wouldn’t even price in three hikes. Interestingly, as I discussed in my thought experiment yesterday, there is even talk of a fifth hike now, or perhaps a 50bp hike rather than every move being in 25bp increments. What is clear is that the market has a bias to see hawkish commentary from these Minutes, and that implies to me that the risk is they are far more benign than currently expected. It wouldn’t surprise me if there were a knee-jerk sell-off in the dollar following the release if the Minutes are simply neutral. At the end of the day, I continue to look for measured inflation to grow more rapidly than the market, and that as it becomes clear that the inflation genie is well and truly out of the bottle, the Fed will be forced to be more aggressive and the dollar will rebound.
I would be remiss if I didn’t highlight an important Bloomberg story this morning, discussing how a large Japanese insurer, Meiji Yasuda Life, has adjusted its investment strategy to take advantage of the simultaneous rise in the yen and rise in 10-year Treasury yields, to begin to purchase Treasuries on an unhedged basis. One thing I have learned over the years is that if one Japanese insurer is executing a strategy, than all Japanese insurers are executing that strategy. To me, this implies that we are going to see short and medium term support for USDJPY as funds flow in this direction, as well as a stabilizing bid in the Treasury market, which should slow the rise in yields there. Of course, counter to that bid is the fact that the Treasury is issuing record amounts of debt and almost certainly going to drive that yield higher. At this point, nothing has changed my view that the 10-year will be yielding 4.0% by the end of the year.
In fairness, we also get another data point this morning, Existing Home Sales (exp 5.63M) although that has not typically been an FX market mover. We hear from both Philly Fed President Harker and Minneapolis Fed President Kashkari today, with the former leaning toward the hawkish side of the spectrum and the latter the most dovish of the entire committee. In fact, it will be interesting to hear what Kashkari has to say, as he has been a strong proponent of pausing the tightening process. The thing is, since we last heard him speak, we have seen significantly higher inflation readings, so the question is will he modify his views or will he simply argue that allowing inflation to run hot is the best policy. My gut tells me that he will go with the latter, but if he were to moderate his language, that would really be news and the dollar would likely benefit as interest rates rose here in response. In the end, I think tomorrow’s comments by Dudley and Bostic will be of more importance to the market, but we shall see.
And that is really all for today. As I wrote above, my sense is that the market is anticipating real hawkishness from these Minutes, so anything less is likely to see the dollar suffer and a rebound in both equity and bond markets.