The markets are waiting for Jay
To testify later today
The hawks are excited
As they feel united
More hawkishness he will convey
Yesterday’s Retail Sales data was the latest data point highlighting the US economy’s continued robust expansion. The 0.5% headline gain matched expectations, but it was the revision higher of last month’s 0.8% reading (which if you recall was much higher than expectations then) to 1.3% that really got tongues wagging. Several analysts raised their expectations for Q2 GDP to above 5.0% in the wake of the report, although the market response seems somewhat puzzling. Both equity and bond markets yesterday were essentially flat, oil prices tumbled more than 4% and the dollar was slightly softer. Arguably, after robust data, one would have expected higher stocks, higher bond yields (lower prices) and a stronger dollar. This should serve to remind everyone that while trends remain in place, there is rarely a one-for-one reaction from data to market prices.
However, what the data does accomplish is paint a picture of a still quite strong economy as a backdrop to Chairman Powell’s testimony to the Senate Banking Committee later this morning. If we have learned one thing about Powell, it is that he is willing to use plain English to describe his views, rather than couch those views in the obfuscation of economic jargon. But perhaps far more importantly, he consistently reminds his audience that there are many important concepts (e.g. the neutral interest rate or the natural rate of unemployment, NAIRU) that are not observable and where the Fed relies on estimates from its models. And while these variables are seen as critical to the PhD set, Chairman Powell recognizes that they cannot be used to fine tune the economy. It is this trait that sets Powell apart from his recent predecessors, and I personally believe, in a good way. At any rate, while the prepared remarks are fairly neutral in tone, there is a growing belief that the Q&A is likely to lean hawkish when it comes to monetary policy questions. However, I imagine that there will also be a significant amount of preening by certain Senators when they lambaste the Fed’s actions regarding banks and the recent stress tests. In fact, my sense is that he will not get to speak too much about the economy, and as such, I don’t expect his testimony to have much market impact at all.
With that said, there is certainly nothing from the recent data that would indicate the Fed is about to slow down its tightening, and the market is now pricing a 62% probability of two more rate hikes this year. In the end, this remains dollar supportive in my view.
Moving on to another economy that seems to be getting ready to tighten policy, UK employment data was released this morning and it was quite strong yet again. The Unemployment Rate remained at its 42-year lows of 4.2%, as 137K more jobs were created in the past three months. Not only that, but Average Earnings at 2.7% continue to print above recent inflation, resulting in real wage gains and a further clue that the UK economy, despite the ongoing Brexit drama and uncertainty, remains fairly solid. Certainly the market expects Governor Carney to raise rates next month, with futures pricing in a greater than 80% probability at this time, and so we will have to see some much weaker data on Q2 GDP or inflation later this week to change that view. The pound has benefitted this morning, edging up a further 0.1%, which makes about 0.5% of gains over the past four sessions. Not that inspiring, but at least logical today.
Overall, the dollar is marginally lower this morning, although it is a mixed picture vs. individual currencies. For example, MXN is weaker by 0.7% on the back of the decline in oil prices with RUB similarly lower by 0.4%. However, other currencies have shown modest strength vs. the dollar, notably CHF, INR and NZD, each with their own idiosyncratic story. The point is there is no overriding theme in the FX market this morning.
One thing I think worth pointing out is that the yen has recently lost some of its safe haven luster. Ever since the financial crisis, the yen had become seen as a haven in the face of market turmoil, rallying when nervousness was evident. I have always thought that characterization misplaced. Prior to the crisis, being short yen to fund other assets was a hugely prevalent position, known as the carry trade. When those assets started to decline sharply during the crisis, all that we saw was those carry trades unwind, which, by definition, included yen purchases. Investors weren’t indicating they preferred yen to other assets; they were closing outstanding positions. But the haven narrative stuck and so we have lived with it for a decade now. Perhaps we are finally coming round to a period where that narrative will diminish, and old havens, notably the dollar and gold, will make a comeback. Certainly the dollar is holding up its end of the bargain overall, so my sense is that gold may not be too far behind if we see another market disruption. In the meantime, the yen has fallen 0.2% this morning and is actually trading back at its lowest level since early January. It would not be surprising to see further yen weakness over the coming months, especially if my thesis on the haven issue is true.
Before we hear from the Chairman, Capacity Utilization (exp 78.3%) and IP (0.6%) are to be released. However, unless something extraordinary prints there, I expect that markets will remain quiet until Powell starts. At that point, it is all up to him.