Probably June

It’s likely appropriate soon
That rates will be raised, prob’ly June
Or so said the Fed
When Minutes were read
By traders Wednesday afternoon

But also, that self-same report
Explained that the Fed would not thwart
A rise in inflation
Unless the formation
Of bubbles caused them to abort

Yesterday’s price action was a study in contrast. The morning was dominated by the growing fear of contagion as the ongoing rout in the Turkish lira led to a decidedly risk-off tone in markets. Equity markets fell around the world and the dollar, yen and Treasuries all rallied. This was even in the wake of the Turkish central bank finally responding to the lira’s sharp decline and raising a key interest rate 300bps. While that had a temporarily positive impact on TRY, it was not nearly enough to turn broader market sentiment around.

But when the FOMC Minutes were released yesterday afternoon, the market gained a new, happier perspective on the world. While the Minutes made clear that the Fed was going to raise rates in June, it remained circumspect on whether there will be one or two more additional rate hikes coming. But what really turned things around was when traders and investors saw the following words, [a period of inflation] “modestly above 2 percent would be consistent with the committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations.” In other words, the discussion about the symmetry of the 2.0% inflation target was reaffirmed.

The implication is that even as inflation continues to print higher over the coming months, and that seems almost baked into the cake given the arithmetic behind the calculation, the Fed is telling us that they are not going to overreact and raise rates more aggressively than currently forecast. I guess the new debate will be on just what defines ‘modestly.’ Is 2.2% modestly above their target? What about 2.5%? Is there even a number that the FOMC members have in mind? However, the one thing that is clear is that the market has reduced the expected trajectory of Fed rate hikes, and that led to very predictable outcomes. The first was that the US equity markets, which had been under pressure prior to the Minutes, all rebounded and closed higher on the day. The second was the dollar, which has been a huge beneficiary of the evolving theme that the Fed was going to get more aggressive, gave back some recent gains. And finally, Treasury yields fell further as the fear over inflation in the long run was overwhelmed by the idea that the Fed would not be in the business of driving the short end of the yield curve up to inversion.

Which brings us to today’s session. The dollar has continued to cede ground, down broadly, although not universally. For example, the most notable data from the Eurozone was a softer than expected German GfK Consumer Confidence print at 10.7, but the euro is still higher by 0.2%. On the positive side, UK Retail Sales in April were much firmer than expected, rising 1.6% in the month, and helping instill some confidence in the prognosis for the UK economy. It can be no surprise that the pound is the leading gainer today, up 0.4%.

But arguably, the most notable news after the Minutes was the new threat of tariffs of up to 25% on imported automobiles into the US on national security grounds. It should be no surprise that car manufacturers’ stock prices have all suffered, or that the equity markets in both Tokyo and Seoul fell after the news was reported. My sense is that this may also be a tacit way for the administration to signal it wants to see the dollar retreat a bit. Remember, back in February both President Trump and Treasury Secretary Mnuchin discussed how a weaker dollar was beneficial to the US manufacturing sector. While we haven’t heard much on that front lately, I’m confident they are not unhappy that their comments are having this effect. But in the end, barring actual activity by the Treasury on the subject, which I think is an extremely remote probability, the market will continue to focus on the Fed, the ECB, the BOE and their brethren central banks. In other words, FX markets will continue to be driven by central bank activity and expectations thereof.

Putting it all together, the implication is that markets are going to be watching the data even more closely as the central banks are truly becoming data dependent. For the Fed, clearly the PCE data is going to be the primary data point, although CPI will still affect market movement. In the UK and Eurozone, I think the growth story will be the driver, as the ECB has made clear they want to remove QE but need justification to do so, and that justification will come from an end to the recent down trend in economic statistics. Japan is still on the inflation train, so higher prints there will offer the opportunity for the BOJ to back away from some of their QQE. And generally, every G10 central bank will be even more focused than usual on the data results.

The dollar has had an awfully good run for the past six weeks, regaining all of its lost ground from earlier this year and starting to cut into last year’s losses. My take is that the Minutes are going to bring a halt to that run for the time being. I don’t expect the dollar to fall sharply, simply to consolidate its recent gains. However, despite the Fed’s clear willingness to allow inflation to rise above their target, I think that is a limited resource, and one that will be used up before the end of the summer. If pressed, while 2.2% is probably not going to raise any hackles on the FOMC, I think that anything above 2.3% will be seen as courting danger and draw out a completely different tone from the Fed. For now, though, it is a waiting game. Better than expected US data will see the dollar benefit somewhat, and worse than expected data will see it fall. Of course, this all presumes that some emerging market doesn’t go pear-shaped, and cause a broader risk-off meme. In that event, the dollar will benefit just like in the old days!

Today brings the weekly Initial Claims data (exp 220K) and Existing Home Sales (5.60M), neither of which seems likely to drive markets. We continue to hear Fed speakers, as well as other central bank speakers, and until the PCE data gets released next week, I expect that will be the most interesting thing to market participants. Early this morning, BOE Governor Carney and NY Fed President Dudley both spoke at a conference and discussed the replacement of LIBOR, not monetary policy. But we hear from both Bostic and Harker later today, and much more importantly, Chairman Powell tomorrow morning. So there is still plenty that can happen.

Good luck