Hard to Construe

The Fed explained that in their view
The future was hard to construe
That’s why they decided
No guide be provided
Instead on the data they’ll chew
In what cannot be a surprise
The market did not think this wise
And so, it transpired
Investors desired
The Fed, its next moves, formalize

There is only one story in the markets today and it began yesterday afternoon with the release of the FOMC Minutes from the July meeting.  Expectations were running high that the Fed would not merely have discussed the formalization of forward guidance but would have come close to deciding to which factors they wanted to tie their future actions.  The mooted choices were the inflation rate, the unemployment rate, the level of the S&P 500 or the calendar.  (Yield Curve Control had already seemed to be a dead issue before that meeting occurred.)  Alas, they did none of the above.  Instead, the Minutes showed that while the discussion was had, no decisions had been made, and given their collective concern that the future path of economic growth could be hindered further by any resurgence in Covid-19, the best course of action was to leave all options on the table.  

Some would contend that this was, in fact, as dovish as the Fed could possibly be.  After all, they simply maintained that they will do whatever they deem necessary to support the economy and the smooth functioning of markets.  But apparently, that is the minority view.  What we saw instead was a clear indication that the investor community thought this was a hawkish outcome as evidenced by both the sell-off in equity markets and just as importantly, the rebound in the dollar.

At this point in time, one cannot read a financial website without seeing at least one article each day about the dollar’s incipient decline.  Futures markets show record short dollar positions and the fundamentalists continually point to the burgeoning twin deficits (budget and current account) as well as the Fed’s ultra-easy monetary policy as the reasons the dollar is soon to fall sharply.  Clearly, the dollar bears were counting on the Fed cementing even more policy ease into the mix, thus undermining the greenback further.

Surprise!  It turns out that the Fed’s unwillingness to commit was seen as hawkish instead.  The result was that the short dollar trade, which has been quite successful this summer (EUR +5.2%, GBP +5.0%, SEK +6.9% since July 1st) had also become increasingly crowded and the lack of commitment by the Fed served as either a signal or an excuse to lighten up positions.  Hence, the dollar, which in fairness had started to rebound yesterday morning, jumped even further and is now nearly 1% stronger than the lows seen yesterday.  It is entirely possible that this is simply a short-term correction in what is potentially a long-term trend of dollar weakness.  It is also possible that this may have marked the medium-term bottom for the dollar as investors reconsider where to deploy their assets.  Just like the Fed explained, the future is very uncertain, especially with the ongoing wildcard of Covid-19 and the potential for a second wave of infections having a significantly negative impact on the economy.  And ironically, if things get worse, especially if it leads to the jettisoning of risk by investors, the dollar is far more likely to rebound further than to decline.

With that in mind, let’s take a look at markets this morning.  The clear theme, following from yesterday’s price action, is that risk is under assault today.  Equity markets in Asia saw declines across the board (Nikkei -1.0%, Hang Seng -1.5%, Shanghai -1.3%) and Europe is a sea of red as well (DAX -0.9%, CAC -1.1%, FTSE 100 -1.15%).  US futures?  All are lower, but in fairness not by very much, less than 0.3% in all three indices.

But bond markets are also seeing risk-off behavior as Treasury yields continue to slide with the 10-year down another 2.5 basis points, to 0.65%, and most European government bond markets rallying as well.  

Commodity prices are little changed as both oil and gold consolidate recent moves.  One thing we can confirm these days is that commodity prices are living up to their historical reputation for excessive movement.  For example, this week alone, gold has rallied more than 3.5% and then reversed all that rally and then some and is now lower by 0.75% since Monday’s open.  That calculates to something on the order of 40% annualized volatility, levels which have not been seen in decades.

Finally, the dollar this morning is doing generally quite well, although it is off its early session highs.  Keeping with the risk-off theme, we have seen both CHF (+0.4%) and JPY (+0.2%) rally alongside the dollar in the G10 space.  Meanwhile, the commodity currencies and Skandies are suffering today with the euro simply unchanged.  In the EMG space, most CE4 currencies are holding their own, having rebounded from early session lows, but we saw pretty consistent weakness from Asian currencies (THB -0.7%, KRW -0.5%) and both TRY (-0.8%) and RUB (-0.7%) are feeling the strain right now.  The baht is suffering as investors have been liquidating equity investments there during an increase in protests over the government’s handling of the Covid pandemic.  The won is also suffering from Covid induced weakness as the number of cases continues to expand and further restrictions are considered by the government.  

Looking ahead to today’s session, we receive some hard data with the potential to alter views.  At 8:30 we get Initial Claims (exp 920K), Continuing Claims (15.0M) and Philly Fed (20.8).  Last week was the first since early March where the Initial Claims data printed below one million, but there continues to be concern that since the US government has not been able to agree on a new fiscal support package, we may see that number start to turn back higher.  That would be dire indeed.  In fact, if we have seen the nadir in the Claims data, we should expect the Fed to become far more active once again, arguably satisfying the investment community and perhaps pushing the dollar lower.  As to the Philly Fed Survey, expectations are for the rebound to continue, but the Empire Manufacturing data on Monday was quite disappointing.  Watch for weakness there as it, too, could result in calls for more Fed ease.

The dollar has fallen a pretty long way in less than two months.  Much of that movement has come from the reduction in overall economic fear.  While Tuesday’s housing data was quite strong, I think the employment situation remains far more important to the Fed and so any indication the recent positive trend is reversing is likely to bring a reaction.  That is likely to halt the dollar’s rebound in its tracks.  Otherwise, another percent or two higher would not be a surprise.

Good luck and stay safe