Powell’s Fixation

Though spending by business has slowed
(And debt from the government growed)
There’s no indication
That Powell’s fixation
On raising rates soon will erode

The Fed left rates on hold yesterday, as universally expected. The policy statement was largely unchanged although it did tweak the wording regarding business investment, which previously had been quite strong but is now slowing somewhat. That said, there is absolutely no indication that the Fed is going to slow its trajectory of rate increases anytime soon. With the meeting now out of the way, I expect that the Fedspeak we hear going forward will reinforce that view, with only Kashkari and Bullard seeking to slow the pace, and neither of them is yet a voting member. The market response was actually mildly surprising in that equities sold off somewhat after the news (and have fallen sharply in Asia and Europe) despite the fact that this was the expected outcome. Meanwhile the dollar has continued to rebound from its recent lows touched on Wednesday, with the euro having declined 0.2% further this morning and 1.4% from its peak.

As an aside, I am constantly amazed at the idea that the Fed, especially as overseen by Jay Powell, is more than mildly interested in the happenings in the stock market. The Fed mandate is clear, maximum employment and stable prices, notably lacking any discussion of rising equity markets. Alas, ever since the Maestro himself, Alan Greenspan, was Fed Chair, it seems that the default reaction has been to instantly add liquidity to the market if there was any stock market decline. The result is we have seen three massive bubbles blown in markets, two of which have burst (tech stocks and real estate) with the third ongoing as we speak. If you understand nothing else about the current Fed chairman, it is abundantly clear that he is unconcerned with the day-to-day wobbles in financial markets. I am confident that if there is a significant change in the economic situation, and markets respond by declining sharply, the current Fed will address the economic situation, not the markets, and that, in my view, is the way policy should be handled.

But back to today’s discussion. I fully admit that I did not understand the market response to the election results, specifically why the dollar would have declined on the news. After all, a split Congress is not going to suddenly change policies that are already in place, especially since the Republican majority in the Senate expanded. And as the Fed made clear yesterday, they don’t care about the politics and are going to continue to raise rates for quite a while yet. Certainly, we haven’t seen data elsewhere in the world which is indicative of a significant uptick in growth that would draw investment away from the US, and so the dollar story will continue to be the tension between the short-term cyclical factors (faster US growth and tighter monetary policy) vs. the long-term structural factors (rising budget deficits and questionable fiscal sustainability). Cyclical data points to a stronger dollar; structural data to a weaker one, and for now, the cyclical story is still the market driver. I think it is worth keeping that in mind as one observes the market.

Regarding other FX related stories, the Brexit situation is coming to a head in the UK as PM May is trying to get her cabinet to sign off on what appears to be quite a bad deal, where the Irish border situation results in the UK being forced to abide by EU rules without being part of the EU and thus having no input to their formation. This is exactly what the Brexiteers wanted to avoid, and would seemingly be the type of thing that could result in a leadership challenge to May, and perhaps even new elections, scant months before Brexit. While I have assumed a fudge deal would be agreed, I am losing confidence in that outcome, and see an increasing chance that the pound falls sharply. Its recent rally has been based entirely on the idea that a deal would get done. For the pound, it is still a binary outcome.

The Italian budget story continues to play out with not only Brussels upset but actually the backers of the League as well. While I am no expert on Italian politics, it looks increasingly likely that there could be yet another election soon, with the League coming out on top, five star relegated to the backbenches, and more turmoil within the Eurozone. However, in that event, I think it highly improbable that the League is interested in leaving the euro, so it might well end up being a euro positive net.

So the week is ending on a positive note for the dollar, and I expect to see that continue throughout the session. This morning’s PPI data was much firmer than expected with the headline print at 2.9% and the core at 2.6%, indicating that there is no real moderation in the US inflation story. This data is likely tariff related, but that is no comfort given that there is no indication that the tariff situation is going to change soon. And if it does, it will only get worse. So look for the dollar to continue its rebound as the weekend approaches.

Good luck and good weekend