More rate hikes? The Fed said, ‘no way!’
With growth slowing elsewhere we’ll stay
As patient as needed
Since now we’ve conceded
Our hawkishness led us astray
If you needed proof that central bankers are highly political rather than strictly focused on the economics and financial issues, how about this:
Dateline January 24, 2019. ECB President Mario Draghi characterizes the Eurozone economy as slowing more than expected yet continues to support the idea that interest rates will be rising later this year as policy tightening needs to continue.
Dateline January 30, 2019. Federal Reserve Chairman Jay Powell characterizes the US economy as solid with strong employment yet explains that there is no need to consider raising rates further at this time, and that the ongoing balance sheet reduction program, which had been on “autopilot” is to be reevaluated and could well slow or end sooner than previously expected.
These are certainly confusing actions when compared to the comments attached. Why would Draghi insist that policy tightening is still in the cards if the Eurozone economy is clearly slowing? Ongoing pressure from the monetary hawks of northern Europe, notably Germany’s Bundesbank, continues to force Draghi to hew a more hawkish line than the data might indicate. As to the Fed, it is quite clear that despite the Fed’s description of a strong economy, Powell has succumbed to the pressure to support the equity market, with most of that pressure coming from the President. And yet central bankers consistently try to maintain that they are above politics and cherish their independence. There hasn’t been an independent central banker since Paul Volcker was Fed Chair from 1979-1987.
Nonetheless, this is where we are. The Fed’s dovishness was applauded by the markets with equities rallying briskly in the US (1.5%-2.2% across the indices) and following in Asia (Nikkei and Hang Seng both +1.1%) although Europe has shown less pluck. But Europe has, as described above, a slowing growth problem. This is best characterized by Italy, whose Q4 GDP release this morning (-0.2%) has shown the nation to be back in recession, their third in the past five years! It should be no surprise that Italy’s stock market is lower (-0.6%) nor that it is weighing on all the European indices.
Not surprisingly, government bond yields around the world are largely lower as well. This reaction is in a piece with market behavior in 2017 through the first three quarters of 2018, where both stocks and bonds rallied consistently on the back of monetary policy actions. I guess if easy money is coming back, and as long as there is no sign of inflation, there is no reason not to own them both. Certainly, the idea that 10-year Treasury yields are going to start to break higher seems to be fading into the background. The rally to 3.25% seen last November may well mark a long term high.
And what about the dollar? Well, if this is the new normal, then my views on the dollar are going to need to change as well. Consider this, given that the Fed has tightened more than any other central bank, the dollar has benefitted the most. We saw that last year as the dollar rallied some 7%-8% across the board. But now, the Fed has the most room to ease policy in comparison to every other G10 central bank, and so if the next direction is easy money, the dollar is certain to suffer the most. Certainly, that was the story yesterday afternoon in NY, where the dollar gave up ground across the board after the FOMC statement. Against the euro, the initial move saw the dollar sink 0.75% in minutes. Since then, it has traded back and forth but is little changed on the day, today, with the euro higher by just an additional 0.1%. We saw a similar move in the yen, rallying 0.7% immediately, although it has continued to strengthen and is higher by another 0.35% this morning. Even the pound, which continues to suffer from Brexit anxiety, rallied on the Fed news and has continued higher this morning as well, up another 0.2%. The point is, if the Fed is done tightening, the dollar is likely done rallying for now.
Other stories have not disappeared though, with the Brexit saga ongoing as it appears more and more likely to come down to a game of brinksmanship in late March. The EU is adamant they won’t budge, and the UK insists they must. I have a feeling that nothing is going to change until late March, just ahead of the deadline, as this game of chicken is going to play out until the end.
And what of the trade talks between the US and China? Well, so far there is no word of a breakthrough, and the only hints have been that the two sides remain far apart on some key issues. Do not be surprised to see another round of talks announced before the March 2 tariff deadline, or an agreement to postpone the raising of tariffs at that time as long as talks continue. Meanwhile, Chinese data released overnight showed Manufacturing PMI a better than expected (though still weak) 49.5 while Non-Manufacturing PMI actually rose to 54.7, its best reading since September, although still seeming to trend lower. However, the market there applauded, and the renminbi continues to perform well, maintaining its gains from the last week where it has rallied ~1.5%.
The US data picture continues to be confused from the government shutdown, but this morning we are due to receive Initial Claims (exp 215K and look for a revision higher from last week’s suspect 199K) as well as New Home Sales (569K). Yesterday’s ADP Employment number was much better than expected at 213K, and of course, tomorrow, we get the payroll report. Given the Fed’s hyper focus on data now, that could be scrutinized more closely than usual for guesstimates of how the Fed might react to a surprise.
In the end, the market tone has changed to mirror the Fed with a more dovish nature, and given that, the prospects for the dollar seem to have diminished. For now, it seems it has further to fall.