Biding Their Time

While markets in Europe are closed
For May Day, the Fed is disposed
To biding their time
Til prices do climb
Or else til slow growth is exposed

As Fed day dawns in NY, market activity has been muted around the world for two reasons. First, it happens to be May Day, an official holiday in 66 nations around the world, including most of Europe, honoring labor solidarity. While May Day was initially a pagan rite of spring (the origin of the Maypole) it was coopted in the mid 1800’s by the International Labor movement as a day to recognize its demands for better working conditions, including the beginning of the eight-hour workday norm. To this day, it remains a labor holiday, with large marches overnight throughout Korea, Indonesia, Taiwan and other Asian nations as well as in Europe, where the French, specifically, are concerned given the recent history of violent protests by the gilets jaunes.

But of more interest is the other reason market activity has been muted, the FOMC meeting ends this afternoon and the market will hear the latest words of wisdom from Chairman Powell at 2:30pm.

There are currently no expectations that Fed policy is going to change at this meeting, at least not by the Wall Street analyst community. Instead, all eyes are on the tone of the statement as well as Powell’s responses to the Q&A at his press conference.

Ever since the Fed’s pivot to patience in January, financial conditions in the US (and worldwide) have eased considerably. After all, government bond yields have tumbled (Treasuries -25bps, Bunds -25 bps, JGB’s -7bps) while equity markets have soared (S&P +21%, DAX +18%, Nikkei +16%). This combination has reduced corporate bond yields in both the investment and non-investment grade sectors, thus freeing up further cash flow and helping to prime the economy’s collective pump. At the same time, as evidenced by Monday’s data, PCE inflation, the number the Fed uses in their models, has fallen back well below their 2.0% symmetrical target, printing at 1.5% in March. The problem for the Fed is that their go to move of preemptive rate hikes when growth starts to pick up has been increasingly called into question. And not just by President Trump, who laughably suggested a 1.0% rate cut for today, but by economists of all stripes who are still at a loss as to why their cherished econometric models no longer represent economic reality.

‘Patience’ seems to be the Fed’s way of explaining that since they don’t have a clue as to what to expect from the economic data going forward, they have decided to sit on their hands. Arguably, that is a pretty good move, although I’m sure they are not keen to admit they are clueless right now. But in the end, it has become clear that throughout the central bank community, the idea of raising interest rates simply because growth numbers improved, if there is no concurrent rise in inflation has become discredited. As long as inflation remains quiescent, at least on a measured basis, the pressure to maintain or cut rates will be enormous. And while every central banker will explain they are apolitical, there is no question that they respond to political pressure like everyone else in government.

So the real question is at what point will central banks start easing further if inflation continues to stagnate? Ironically, I would argue that central banks have painted themselves into a different corner lately, continuously making the claim that 2.0% inflation, or thereabouts depending on the country, is necessary to insure a healthy economy. But if growth is solid and inflation is falling, are they going to cut rates further, to the extent possible given current levels, in order to revive inflation at the risk of blowing asset bubbles? And that doesn’t even consider the issue for Japan, Sweden, Switzerland and the Eurozone, where interest rates are already negative, and how those central banks will respond if either growth or inflation weakens more aggressively. The point is, despite all its warts, it continues to be clear that the US economy remains the most attractive place to invest capital. And with that, the dollar will continue to be supported.

Recapping the most recent data shows that yesterday’s Chicago PMI was quite disappointing at 52.6, well below expectations and the lowest print in more than two years. A harbinger of the future or an outlier? We will find out more this morning when the national ISM number is released (exp 55.0). The other data point of note in the US yesterday was Case-Shiller Home prices, which rose only 3.0%, reinforcing the idea that the housing market continues to cool. Meanwhile, Canadian GDP for February printed at -0.1%, with forecasts for Q1 now falling down to stagnation north of the border. So even though the housing market in the US is under modest pressure, the broad economy here continues to outperform just about everywhere else in the world.

This morning we also see ADP Employment (exp 180K) and then the Fed speaks. Overall, the dollar has been under modest pressure for the past several sessions, but all told, the movement has barely been a 1% decline. And while choppy, the trend remains in the dollar’s favor at this point. I have yet to see an argument that supports a much weaker dollar, at least on a cyclical basis, and as such, see no reason to change my views of further dollar strength ahead.

Good luck