Doves vs. Hawks

The commodity currencies of Canada, Australia and New Zealand led the way higher in FX last week underpinned by firmer commodity prices and an improving China. The commodity futures price index, the CRB, has advanced for 8 weeks since putting in a double bottom in early February. China’s industrial output and retail sales surged in March urging greater confidence that China’s economy has stabilized and will avoid a hard landing. Of course, the better the Chinese economy performs the better the continued advance for commodity prices.

There were no less than eight Federal Reserve Presidents speaking last week. Some were doves, some were hawks, some were FOMC voting members, and some were not. One wanted a rate hike in April; others ruled out an April hike but favoured a June hike; and one (Lacker) was busy making a case for four rates hikes in 2016 – I kid you not. I don’t know about you, but methinks that continued pontification by US Fed members is starting to fall on deaf ears. I think the market is sensing this as well – US Fed fund futures is pricing in 2% chance of a rate hike at the April FOMC meeting, 13% for June, 28% for July, 36% for September, 40% for November, and 52% for December, 55% in February 2017. In other words, the market is pricing in no rate hike until 2017.

So with possible interest rate hikes being pushed out further in time, the USD continued to be shunned. U.S. economic reports didn’t help the dollar’s cause either. A horrible retail sales report and a disappointing inflation report undermined the US Fed’s interest rate hike expectations.

At the time of this writing, we learn that the world’s major oil producers failed to reach an agreement to freeze oil production at this weekend’s OPEC and non-OPEC meeting in Doha. No one should be surprised by this as, over a month ago, the Saudis stated that there would be no agreement without Iran’s participation. There was no way that Iran would agree to freeze production now that they have been allowed to sell oil again on the world market after agreeing to forgo their nuclear ambitions; and the Saudis knew this. The price of oil and the CAD have steadily gone up over the past two months on hopes of a deal.

Yellen Too Loud

The first trading day of the week was very lackluster with little to move the currency markets either way due to the Easter holiday break. This only helped to raise the anxiety level of traders as they waited for Tuesday’s speech at the Economic Club of New York by Fed Chair Janet Yellen. The question on everyone’s mind was did she mean to sound as dovish as she did in her post-FOMC press conference in mid-March, especially since various Fed presidents had taken a more hawkish tone since then. The answer is yes, she absolutely meant to sound dovish.

The third paragraph of her speech is very telling, it reads as follows: “In my remarks today, I will explain why the Committee anticipates that only gradual increases in the federal funds rate are likely to be warranted in coming years, emphasizing that this guidance should be understood as a forecast for the trajectory of policy rates that the Committee anticipates will prove to be appropriate to achieve its objectives, conditional on the outlook for real economic activity and inflation. Importantly, this forecast is not a plan set in stone that will be carried out regardless of economic developments. Instead, monetary policy will, as always, respond to the economy's twists and turns so as to promote, as best as we can in an uncertain economic environment, the employment and inflation goals assigned to us by the Congress." In other words, the Fed should proceed with caution and with a gradual approach in adjusting policy.

Ok, so Yellen stressed a “gradual approach” to Fed policy and, just in case the economy goes sideways or worse, the Fed is prepared to employ additional "money" printing (QE): "Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long-term interest rates and so support the economy--specifically, forward guidance about the future path of the federal funds rate and increases in the size or duration of our holdings of long-term securities. While these tools may entail some risks and costs that do not apply to the federal funds rate, we used them effectively to strengthen the recovery from the Great Recession, and we would do so again if needed." Really, we are back to this again. How successful was QE anyway? Not very, considering QE1 was followed by QE2, Operation Twist, and QE3.

Here is another unsettling part of the speech: "The FOMC left the target range for the federal funds rate unchanged in January and March, in large part reflecting the changes in baseline conditions that I noted earlier. In particular, developments abroad imply that meeting our objectives for employment and inflation will likely require a somewhat lower path for the federal funds rate than was anticipated in December. Given the risks to the outlook, I consider it appropriate for the Committee to proceed cautiously in adjusting policy. This caution is especially warranted because, with the federal funds rate so low, the FOMC's ability to use conventional monetary policy to respond to economic disturbances is asymmetric." So what you’re telling us is that the Fed’s “data dependency” will now include data like Japanese inflation, European GDP, and Chinese PMI – you get the picture.

It appears that Janet Yellen is not only dovish but she is a lot more dovish than anyone previously thought. To illustrate this point, the ninth footnote in the text of her speech stated “uncertainty and greater downside risk” when the Fed’s policy rate is so close to zero “call for greater gradualism.”

At the time of this writing, fed funds futures traders have revised down the implied probability of a June rate hike to just 26%, and “only” a 66% chance of another rate hike at all this year.

In the currency trade, it’s no surprise the the USD took the brunt of Yellen’s dovishness as it lost ground to all the major currencies. During the past week, multi-month highs for the AUD, NZD, and CAD were recorded. The big question is will the gains in commodity currencies last – investors are seeing the spike highs and the natural inclination is to think of exhaustion followed by reversals.

In other parts around the world the yen is the best performing currency in Q1, which is surprising since the Bank of Japan decided to up the ante with the introduction of negative interest rates. The GBP was in last place which is not surprising as the currency is being weighed down by the uncertainty of Brexit. To underscore this point, the global manufacturing PMIs were released on Friday and the only one that missed its mark was from the UK where the PMI reading printed at 51 versus 51.2 forecast. By the way, the PMI for China surprised to the upside with manufacturing activity expanding for the first time in 8 months – does this mean Yellen will raise rates – sorry we’re confused.

CAD Casualty

The CAD was the main casualty of the USD’s reversal, falling 1.95% on the week, which ended a nine week rally. The possible culprits for the drop in the loonie were the slump in the price of oil and/or the release of the Canadian Federal Budget.

The world’s eyes were on Canada last week as it became the first major industrialized country to opt for fiscal stimulus rather than rely solely on monetary easing. The Organization for Economic Co-operation and Development and the International Monetary Fund has stressed the need for governments to turn to fiscal policies instead of monetary central bank policies; and the Canadian government delivered by promising to spend more on infrastructure to boost growth. The Canadian Finance Department estimates that the stimulus spending will drive 0.5% of GDP growth. The government is putting the bulk of its effort on the middle class and expecting a positive spillover to the rest of the economy. The bad news is that federal finances will go from a near-balanced position of the past two years to big budget deficits of almost $30 billion (or 1.5% of GDP) for each of the next two fiscal years. Canada’s pristine balance sheet will be affected in the short term but with the current global backdrop this will be acceptable. The key for the currency will be for the medium term – will the government be able to reverse the deficits down the road? We will come back to this point in four years’ time.

With the cumulative burden of big deficits down the road, the CAD was weighed down more by the combination of a firmer USD and the lower price of crude. The price of oil approached the 200-day moving average around the $42 level last week and backed off after U.S. crude inventories jumped more than expected and gasoline stockpiles fell. The Energy Information Administration reported U.S. crude stocks rose by 9.4 million barrels in the previous week to a record total of 532.5 million barrels. Offsetting the build was a 4.6 million barrel decline in gasoline inventories. The EIA also said weekly production ticked down by about 30,000 barrels per day. This spells trouble for oil and the CAD as inventories are at all-time highs nearing full capacity as we approach the spring maintenance season for refiners.

The USD/CAD rate has moved up through the overhead downward sloping trend line drawn off the mid January high. The technical indicators are also aligned with the up move in the rate with the RSI rising and with the crossover in the MACD. A move to the 200-day moving average would be constructive. Also, if the price of oil were to fall below the shelf carved out at just above the $36 level then the USD/CAD rate could attempt to reach the falling 50-day moving average.

During the previous week, the US Fed’s actions sent the USD reeling but that all changed last week as the USD climbed out of the basement to the top of the heap. The USD was well bid all week as nearly half of the regional Federal Reserve presidents appeared more willing to support rate hikes than was the impression following the previous week’s Fed meeting and press conference by Janet Yellen. Of course, this may have been an attempt by the Fed to steer markets away from their post-FOMC conclusion that the Fed was safely out of the picture for the next few months. Thus, the regional Fed presidents were successful at injecting some speculation about the appropriate number of rate hikes this year and adding some uncertainty about a possible hike in the April or June meetings. Any time a regional Fed president is a little more hawkish or less dovish it is USD supportive.

Meanwhile, the GBP was at the bottom of the heap following the release of soft inflation data and an increase in the odds of the UK leaving the European Union in the June referendum in the wake of the Brussels terror attacks. With immigration as a key issue in the referendum, the GBP was knocked down as traders presumed that British voters might seek to distance themselves from the EU and the terrorist attacks that took place first in Paris back in November and now in Brussels. The February inflation reading added to the GBP’s pain. The 0.3% reading is unchanged on the previous month and was below the forecast of 0.4%.

Gold Wins by Default

The Japanese Yen was the biggest winner last week, surging despite negative fundamentals like the 0.4% decline in preliminary Japanese GDP for the fourth quarter. Despite all the gloom and doom, the Japanese yen has not only held its own against the strong US dollar, but posted a superb rally. How is this possible? Well, the Yen simply maximized its traditional safe-haven status, and global financial instability drove investors away from risk assets towards safer waters like the Japanese currency. The recent rush to safe assets will not last indefinitely however, and weak fundamentals will not fade away for this island country. Losers last week include, the Swiss Franc which experienced a retracement from the previous week’s gains.

On of this week’s major themes is the fact that an increasing number of central banks are employing negative rates – Europe, Denmark, Sweden, Switzerland and now Japan. What does it mean? And who’s next?

Well, negative rates signal slight desperation on the part of central banks. It suggests that traditional policy options were not effective and that new drastic measures are needed. Rates below zero also mean that there is minimal expectation of inflation and little to no anticipation of near-term economic rebound. How well negative interest rates have worked in the past is debatable, but most economists think they've had some success in Europe. Lowering rates has helped stem the appreciation of the Swedish and Swiss currencies and significantly pushed down the value of the Euro against the Dollar, which was a nice boost for exporters in the Euro Zone.

Well, negative rates signal slight desperation on the part of central banks. It suggests that traditional policy options were not effective and that new drastic measures are needed. Rates below zero also mean that there is minimal expectation of inflation and little to no anticipation of near-term economic rebound. How well negative interest rates have worked in the past is debatable, but most economists think they've had some success in Europe. Lowering rates has helped stem the appreciation of the Swedish and Swiss currencies and significantly pushed down the value of the Euro.

As for who is next, The Bank of Canada is the most likely of the major central banks to opt for negative rates this year, claims Marc Chandler, head of FX Markets Strategy at BBH. "I am not saying the Bank of Canada will, but that is the most likely candidate of those that are not there yet…” Canada's current overnight rate is already very low and the BOC has prepared markets for the possibility of negative rates by alluding to how they might work as a policy tool. Back in December, Stephen Poloz said the lower bound for the policy interest rate was around minus 0.5%. The bank will update its rate target on March 9.

In the US, it remains an open question whether the Fed will adopt negative rates in this environment. They seem to be enjoying a stronger economy than most, but everyone’s eyes will be on the data in coming weeks to see if it will warrant a drastic policy shift at the FOMC meeting in March. A change in economic circumstances could put negative rates “on the table” in the U.S., but unless the economy weakens significantly many analysts expect Fed policymakers to slowly raise rates, and not cut them. “I do not see this as anything but very low risk in the U.S." states Chandler.

In theory, rates below zero should reduce borrowing costs for companies and households, driving demand for loans. In practice however, a bank charging customers to hold their money, may cause cash to go under the mattress, or perhaps somewhere shinier...

It seems that the threat of negative rates across the globe has made Gold one of this year’s best investments. Negative rates, in simple terms, means that depositing cash will leave investors with less than when they started, making traditional assets such as gold more appealing. “Leave a million dollars with a bank, and in a year, you get only something like $990,000 back,” said Marc Faber, publisher of the Gloom, Boom & Doom Report. “I would rather want to own some solid currency, in other words gold.” All in all, when you have negative rates, something with a 0% yield becomes a high-yield asset and is therefore a nice place to park your money

Five and Counting

At the end of last week’s blog post, we mentioned that the central banks of Japan, New Zealand, and the USA would deliver policy announcements. We went on to say that no moves were expected by all three banks but if there was to be a move it would come from the Reserve Bank of New Zealand. On this count, we were half correct. There was a surprise move but it came from Japan not New Zealand, more on that later.

The big surprise of the week was the Bank of Japan adopting negative interest rates. The BOJ will charge 0.1% on any cash left on deposit with the bank. The yen responded with a loss of almost 2% on the week. This move shocked the markets because only a week ago Bank of Japan Governor, Haruhiko Kuroda, told an audience at the Davos World Economic Forum that he would not adopt negative interest rates. The bank’s policymakers, who voted 5-4 to approve the measure, took great pains to say the rate cut was based on global conditions and not the Japanese economy itself. It makes you wonder what the BOJ has seen that has changed their minds so quickly. It also makes you wonder why the Fed’s policymakers are not seeing the same thing.

The BOJ’s latest move makes it five and counting – i.e. five central banks that currently have a negative interest rate policy. The others are the ECB (-0.3%), Denmark (-0.65%), Switzerland (-0.75) and Sweden (-1.1%). We are emphasizing “and counting” because we believe that eventually other western central banks, including the US Fed, will have no choice but to adopt negative interest rates.

There were some changes in last Wednesday’s FOMC statement. The FOMC removed the line about the economy “expanding at a moderate pace” and replaced it with “growth slowed late last year”. They warned that market based measures of inflation compensation “declined further” and that inflation is expected to “remain low in the near term, in part because of further declines in energy prices.” The FOMC also explicitly said they were closely monitoring global economic and financial developments. These were nice dovish additions but we thought that the dropping of “risks being balanced” and the reference to being “reasonably confident” about inflation returning to 2% was more telling.

The changes to the FOMC statement reinforced what the market had already discounted – that the Fed's four rate hikes, as laid out in December’s dot-plot, are a fantasy. Before all the market turmoil in January, the fed funds futures were pricing in just two rate increases by year-end. The market is currently pricing in a single hike this year and traders see a 16% chance that the Fed will raise rates at its March meeting, down from 51 percent at the start of this year.

Looking ahead, it will be another busy week in the currency markets. The first trading week in February will see the release of Chinese PMI, UK PMI, RBA Rate Decision, German Labor Report, NZ Labor Report, BoE Rate Decision & Quarterly Report, US Non-Farm Payrolls, and the Canadian Employment Report.

Turning the corner?

The price action in the CAD and the GBP have demonstrated that a change in trend has occurred. The CAD had dropped for the first 12 trading days of the year. On Wednesday the losses stopped and the CAD went up for 3 straight days. The combination of the turnaround in the equity markets on Wednesday, the decision to stand pat on monetary policy by the Bank of Canada (also on Wednesday), and the 3 straight days of gains in crude oil (10.85% on the week) help cement the interim bottom in the CAD. Wait a second, I know what the regular readers of our blog are thinking right now – didn’t we say last week that the CAD had the potential to reach the 1.60 level due to the bust of the commodity super cycle? Yes we did and that is why we are calling last week’s bottom in the CAD as an interim bottom. Time will tell if this is the beginning of a correction before going to 1.60 or if it is a change in trend – the price action will determine that.

The price action in the GBP was also indicative of a turnaround. The GBP had steadily declined from the 2.090 level in early December until the about face in mid-week which broke the prevailing momentum. To further demonstrate this point, the GBP traded sharply higher on Friday despite a fall in retail sales that was three times larger than the consensus expected. When a currency rallies despite bad news this tells us that change is afoot.

Looking ahead, it will be another busy week in the currency markets. Along with the various economic reports due to be released, the central banks of Japan, New Zealand, and the USA will deliver policy announcements. No moves are expected by all three banks but if there is to be a move it will come from the Reserve Bank of New Zealand which could cut by a quarter point. After delivering its first rate hike in a decade, the Federal Reserve is not expected to make a move. However, it would be a total surprise if the FOMC statement did not contain a hint of concern over the recent volatility in equities and commodities. If it does then the USD will take a hit.

US Federal Reserve Interest Rate Talk Again...

Honestly, after last week’s anticlimactic FOMC decision we thought
that we would get off this topic of interest rate hikes and move on to
other market drivers. Unfortunately, we demur as the issue has
come back, front and center, and is vying for top spot in the news
cycle along with the VW’s exhaust issues (food for thought: Chinese,
Indian or Korean automaker to buy Porsche from VW?). The USD was
able to pick itself up off the mat and finish at the top of the currency
heap last week. The week prior, the USD was down and out due to
the market’s perception of a dovish hold after the FOMC meeting.
Sound bites from several Fed officials and a speech by Chairperson
Yellen were able to transform the market’s perception from a dovish
hold to a hawkish hold. This policy stance is grounded in the fact that
most Committee members continue to project a policy rate increase
later this year, even though the conditions that led to a delay in a
September rate hike are likely to persist in the months ahead. Thus,
as long as U.S. policy normalisation remains on the table, the
divergence between the Fed and the continued monetary easing of
other central banks, especially the ECB and the BOJ, should continue
to cause the USD to trade with a strengthening bias.

The worst performers last week were the GBP and AUD. The GBP has
plainly run out of gas. The Bank of England is the only other central
bank besides the US Federal Reserve that is close to raising interest rates. There
wasn’t any key market moving data releases last week but there was
conflicting central bank commentary. Sir Jon Cunliffe asserted that
the UK’s economic outlook was ‘pretty strong’ and that the next interest rate related movement was likely to be an increase, however, fellow Monetary Policy Committee member Ben Broadbent stated that he wouldn’t be voting for higher borrowing costs anytime soon. Since the UK economy appears to have slowed in Q3, Broadbent’s comments carried more weight and helped the GBP fall by 2.5% last week. The focus for next week will be revisions to Q3 GDP and the PMI manufacturing report.
The other poor performer last week was the AUD. The AUD dropped below 70 cents intraday last week and is down about 20% over the last year primarily due to the China slowdown story and the slump in commodity prices. China is Australia’s biggest trading partner so any negative news about China’s economy tends to weigh on the AUD. Last week’s negative China news was the Caixin PMI, which showed that manufacturing activity contracting at the fastest pace since March 2009. The other driver of Aussie weakness last week was a report by ANZ Bank that suggested that the Reserve Bank of Australia may cut rates twice in 2016 taking the benchmark rate to 1.50%. If this were to happen, the next likely target on the monthly price chart would be around the 0.60 level last seen in late 2008.

Enough already - Get on with it!

The stabilization of Chinese markets during this last week has helped to lower volatility and ease safe haven flows into the USD and Japanese yen. The AUD was the best performing currency last week powered higher by better than expected employment data. The month of August saw 17K new jobs created, the unemployment rate easing to 6.2% from 6.3%, and with July job growth revised up. The Aussie also received some help from higher copper and iron ore prices. Surprisingly, the NZD was able to eke out a gain of 0.58% on the week despite a cut in interest rates of a quarter point to 2.75% by the central bank. The yen was the worst performer thanks to China’s stabilization, poor data, and political jawboning. Japan’s machine tool orders fell 3.6% on the month and producer prices fell by 3.6%. Prime Minister Abe’s economic advisor, Kozo Yamamoto, created a firestorm when he said that the Bank of Japan should expand its monetary easing program by at least 10 trillion yen at its October 30th policy meeting. Yamamoto said reaching the bank’s 2% inflation target in the first half of the fiscal year beginning April 2016 is an "absolute imperative".

All eyes will be on the Federal Reserve this week as they decide whether to increase interest rates for the first time in 9 years at its September 17th policy meeting. Last week, Fed Chair Yellen’s favorite jobs indicator, the US JOLTS data, showed a large jump in total job opening though hires lagged behind (for sixth month). However, the state of the U.S. economy hasn’t been the focal point for a rate hike since early August. The Fed was edging closer towards a hike at their September meeting before China devalued their currency, which caused equity markets around the world to destabilize spurring wild volatility and tightening of financial market conditions.

Well, we’re finally here. The stage has been set. The issues for and against a rate hike have been debated ad nauseam. The uncertainty of all of this has become unbearable – enough already and get on with it! Whatever the decision is, it will most certainly cause volatility to ramp up. A hike will deepen the fear of a global deflationary spiral caused by a stronger USD and/or a Chinese hard landing. Standing pat will keep the threat of such a hike ongoing into each subsequent meeting in October and December.

The U.S. dollar index has limped into the end of the week. Its technical condition is tenuous at best with the momentum indicators all pointing lower while it sits just about its 200-day moving average. It looks set to continue its sell off until the FOMC decision.

You’ve probably asked yourself what’s the big deal about a quarter point hike in interest rates when the fed funds rate is near between 0 and 25 bps. Well, if the Fed hikes by 25 bps then interest rates have effectively gone up by 100%. This alone has the ability to cause ripple effects across the derivative world of interest rate contracts which in turn has the ability to cause interbank credit risk. This is why the TED (TED spread definition) spread has been moving higher since China's devaluation. According to Head of Global Investment Research for Alhambra Investment Partners, Jeffrey Snider, the TED spread is now where it was in the weeks just following the flash crash of May 2010 and equal to October 2011, after the SNB pegged the CHF to the euro and the Fed reproduced dollar swaps globally.

Position Adjustment - Euro was the top performer last week, US keeps interest rates at its current level and this Friday's April US non-farm jobs report will be in focus

What a week! The euro was the top performer on the week with a gain of over 3% and at one point moved a whole four euros against the USD. Technically, the euro rally may have run its course giving up almost a full euro on Friday and after having met the 61.8% Fibonacci retracement and coming within a whisker of its 100-day moving average. The price action in the euro last week caused clients, with euro exposure to their business, to call us with questions about what was happening. The simplest explanation is positioning. The euro has been the most heavily shorted currency in the futures market for some time now, so when everyone in the boat is leaning one way and a big wave hits the boat the result is that the wave redistributes the weight (position adjustment). Thus, the big move in the euro was due to a short squeeze as speculators bought the euro in order to exit their short trade and not due to a fundamental change in the prospects in the Eurozone.

 

The catalyst for the move was a combination of a poor reading for Q1 GDP and the FOMC announcement. The US Federal Reserve, as expected, kept interest rates at its current level, but offered little hints on the timing of its first rate hike in nearly a decade. What the Fed did do was to remove all calendar references on a potential window for raising its benchmark Fed Funds Rate making very clear that rate decision will be a data driven. Furthermore, the Fed said it will take into account labor market conditions, inflationary pressures, and expectations of international financial developments when it decides on the timing of a rate increase.

 

 

The latest reading of Q1 US GDP came in at 0.2% which essentially demonstrates that the economy stagnated in Q1, or to sugar coat it, the economy grew very, very, very slowly. This was a huge deceleration from the Q4 2014 when real GDP gained 2.2%. Economists on average were anticipating growth of 1% in Q1. How bad was it? Well, if it wasn’t for the biggest inventory build in history, which grew by $121.9 billion and merely remained flat, US Q1 GDP would not be 0.2%, but would be -2.6%.

 

Just like a year ago, many economists and investors are pointing to snowy winter weather as the root of the weakness. Other factors holding back growth this time around may have included the strong USD, pressure on the energy sector from lower oil prices, and dock worker strikes on the West Coast that disrupted that flow of trade. All of these excuses are what the Fed calls "transitory factors". Therefore, as long as inflation keeps moving to the Fed’s target and that the economy sees further improvement in the labor market then the Fed will be looking for an opportunity to raise interest rates. Having said this, this Friday’s April non-farm jobs report will be in focus. A strong report will keep a June rate hike as a possibility. A weak report would not only rule out a June rate hike, but would put into question a move in September as well.

 

 

The technical condition of the US dollar index is on much firmer ground after last week’s price action. The index has found support near the 50% Fibonacci retracement, the 100-day moving average, and the shelf of support which was carved out from mid-January to the end of February.

 

Furthermore, the RSI has turned up, the MACD looks to be making a bottom, and the full stochastics have crossed and turned up. The technical foot print makes us wonder if the chart is forecasting a good jobs number and thus a turn in the economic data, which dovetails nicely with the Fed’s transitory factors and the beginning of warmer weather.

 

 

 

Slip Sliding Away - "soft economic data" you Need to know about Tomorrow's US FOMC Statement

　

Just how fragile is the US dollar right now? It can’t even muster up a gain against the political backdrop of its cross Atlantic rivals, the UK and Europe. The GBP was the best performer last week despite all indications that the UK general election on May 7th will end with no clear cut winner resulting in a coalition-forming government with potential referendums on Scottish independence or an exit from the EU. Meanwhile, the euro was the second best performer despite not being able to come to an agreement with Greece and its mountain of unpayable debt.

The U.S. economic outlook continues to be plagued by soft data, which is making USD bulls nervous as their bullish stance appears to be slip-sliding away. The USD bullish case is predicated on the fact that the Fed will raise interest rates between June and September while the rest of the global central banks stand pat, but the continued tide of soft economic data questions this thesis. Last week it was the combination of new home sales, initial jobless claims, Markit PMI, and the durable goods report. All were less than stellar, which weighed on the USD. Of course, this string of bad news is good news to the equity markets which rallied to a record high as U.S. Treasury yields slipped.

Ever since the Fed dropped "patience" from their FOMC statement the media has proclaimed that the Fed has become data dependent. You have good reason to chuckle because when hasn’t the Fed been data dependent? With this in mind, market participants now pay more than cursory attention to second and third tier data, which barely drew attention in the past, in hopes of gleaming insight into the timing of the Fed’s first interest rate hike in more than 6 years. Having said this, the market appears to be less confident in the US economy and in the ability of the Fed to deliver said rate hike which is weighing on the USD.

 

Tomorrow's FOMC statement could spell more problems for the USD as the Fed meets. Without a news conference or updated projections, the FOMC statement will be the focus. If the statement acknowledges the broadly weaker data for consumption, manufacturing, and the labor market in recent months then the USD will sell off quickly. However, if the Fed sticks with their transitory argument for the recent string of weak data then USD bulls will breathe a collective sigh of relief. We suspect that the greater challenge for USD bulls will be the April employment report on May 8, especially after the disappointing March report.

 

 

US Consumer Spending Disappointment

 

The USD continued its correction this past week, which was triggered by the removal of the word "patience" from the FOMC statement. This in turn caused the market to re-evaluate the timing of the Fed’s first rate hike from June to sometime in Q4. The currencies that performed worse than the USD were the AUD, CAD, and GBP as each one had its own cross to bear. The AUD closed at its low for the week as the market is pricing in additional interest rate cuts from the central bank with its next meeting on April 7. The CAD initially received a boost from comments made by Bank of Canada Governor Poloz on Thursday, which suggested that near-term interest rate cuts were unlikely. However, the gains in the CAD quickly dissipated after the sharp sell-off in oil ahead of the weekend. Meanwhile, the GBP was weighed down by low inflation, dovish comments by various Bank of England members, and uncertainty ahead of the May federal election. The latest polls show that Labour has 36 and is now ahead of the Tories with 32, Ukip has 13, Liberal Democrats have 8, and the Greens hold 6. The early polls point to a confusing and complicated post-election power sharing coalition, which will continue to weigh on the GBP even after the May 7 vote.

Lately, it seems that U.S. economic data is consistently missing the mark. We are not saying that the data is bad – not at all – what we are saying is that it has been less than stellar. A quick view of Citi’s Economic Surprise Index captures what we are saying. The index gauges how the actual economic activity compares to expectations – so the data can be very good but miss expectations. Notice how the indicator when compared to Europe and China shows stark contrast.

United States Consumer Spending

There are days when U.S. economic data demonstrate the U.S. economy that is finally getting on track for accelerated growth. Other days, the statistical data demonstrate that we are stuck in an anemic "new normal" that has beleaguered the economy the last few years. Although we rarely get an unambiguous picture from economic statistics, recent reports have proven particularly confusing. With the Federal Reserve now primed to begin tightening monetary policy, there is also a lot riding on what those reports disclose.

 

Encompassing roughly 70% of total GDP, consumer spending has been the life force of U.S. economic growth for many decades. Over this cycle, household incomes have been inhibited by persistent unemployment and the snowballing effects of slow wage growth. To make matters worse, nondiscretionary expenses (e.g., taxes, medical care and educational costs) have climbed much faster than income. Since the average household spends the majority of what it earns, consumption growth has been profoundly constrained by the lethargic growth of discretionary income.

Consumer spending in the U.S. increased 0.10% in February of 2015 over the previous month. Consumer spending in the U.S. averaged 0.55% from 1959 until 2015, reaching an all-time high of 2.75% in October of 2001 and a record low of -2.02% in January of 1987. Personal Spending in the U.S. is reported by the U.S. Bureau of Economic Analysis.

 

Contrary to the expectation that falling energy prices would cause other retail sales to rise, however, the sales statistics actually fell over the last three months. Retail sales declined 0.6% in February after falling 0.8% in January and dropping 0.9% in December. We should not have been surprised. Keep in mind that gasoline sales also count as consumer spending, so the majority of the drop in the retail numbers came from reduced sales of gasoline. For overall consumer spending to rise, Americans need to spend more money on other goods or services than they save on gasoline. That means that unless consumers dip into savings or aggressively spend any additional income they receive, we probably should not see a large increase in overall consumer spending. There is also evidence that much of the growth in other spending will lag the decline of gasoline sales by a several months.

 

The savings on gasoline come at the rate of $10 to $20 per week, as drivers recurrently fill their tanks. While that is enough to fund the purchase of small ticket items like restaurant sales, it would take some time to accumulate savings for larger purchases. That means reduced energy costs should be expected to reduce consumer spending during the initial months of a transition to lower energy prices, but much of the increase in spending on larger-ticket items would likely come after some time has passed.

 

 

 

US FOMC Announcement

Fed Drops Patient Stance
Opening Door to June Rate Increase

 

 

 

 

 

“Just because we removed the word patient from the statement doesn’t mean
we are going to be impatient,”

Chair Janet Yellen said in a press conference Wednesday in Washington.

 

Click here for the full article

 

 

 

Allusion of Ever-Present Peril

Flippity-Flop

The highlight of last week was the release of the Fed minutes from the FOMC meeting on January 28th 2015

The FOMC statement from that meeting left a hawkish impression on the market, however, the minutes showed that Fed members were much more cautious, with many members saying they were inclined to stay at zero for longer. Members expressed concern that raising interest rates too soon could pour cold water on the U.S. economic recovery, and fretted over the impact of dropping "patient" from the central bank's rate guidance. Members also grappled with the weakness in international markets as well as worrying about falling inflation expectations in the U.S.

The flippity-flop in terms of the perception of the Fed’s first interest rate increase has had a hand in sidelining the USD as of late. The market will now look towards Fed Chair Janet Yellen’s testimony before Congress next week for insight into what the Fed is thinking. If Yellen comes across as hawkish then the market will expect a rate hike at the June meeting. However, if Yellen takes pains to explain the risks from a prolonged decline in inflation and the uncertainty in the international outlook then the uncertainty in the Fed’s first interest rate hike will continue to dog the USD.

Sword of Damocles

 

Finance ministers from the 19 countries comprising the Euro group has granted Greece a critical 4-month extension to its massive debt bailout so that officials can work out a longer term deal thereby prolonging the state of looming disaster for the shaky economic union. After trading many jabs and insults, it is safe to say that the easy parts of the negotiations are over. The deal won’t go into effect until the various national legislatures around Europe have approved it.

In some countries, particularly the Netherlands and Europe, this will be a tough sell. Understandably, some countries are frustrated at seeing their euros flow into a country whose economy never seems to improve.

The deal will mean that Greece will temporarily avoid going bankrupt as their financial lifeline is extended for 4 months. It should also mean that capital controls will not be needed and that Greek banks will have enough money to stock up their ATM’s. However, to get the money, the Greek government has one more hurdle to clear, which is to present a series of unspecified economic reforms measures that are deemed acceptable by creditors and rooted in Greece's previously enacted bailout agreement – something the government had promised not to do. Greece’s Prime Minister, Alexis Tsipras, now has to sell the Brussels deal and an eventual long-term agreement with the Eurozone not only to voters, but to Syriza's left wing and his junior coalition partner, the right-wing Independent Greeks.

These economic reforms should have been presented at the time of this writing. Notably, the Greek government will be the author of the reforms pursued, which has a rallying cry for the Syriza Party during Greek election campaigning. This represents a change from the past 5 years when Greece has relied on rescue money to avoid going bankrupt and was effectively ordered to enact a series of austerity measures by Berlin and Brussels.

Mixed Signals

 

 

The USD ceded some ground to the other majors this week, in spite of a late rally. As you can see from the one day relative performance table, investors were caught leaning the wrong way ahead of the week’s main data release, Friday’s non-farm January payrolls report on the US labour market. The report smashed expectations as the economy added 257K jobs, far above the 230K that was expected. In addition, the November and December reports were revised up by 147K making it the strongest three months of jobs gains in 17 years. Not to be outshined, average hourly earnings surged from last month's disappointing -0.2% to a whopping 0.5%, which was the highest monthly jump in average hourly earnings since November 2008. However, on an annual basis the increase was a less impressive 2.2%. Nevertheless, these reports restored a large amount of faith in the US economic recovery. Sentiment had been firmly against the USD since the beginning of January as U.S. economic reports were sending mixed signals about the strength of the economy and the timing of the Fed’s first interest rate hike. Doubts about the Fed’s timing arose after disappointing December average hourly earnings and retail sales. Other reports adding to the discourse was the falling employment component in both the ISM Manufacturing report and the ISM Non-Manufacturing report and the 17.6% rise in layoff announcements in the Challenger Grey & Christmas reports.

 

Friday’s very strong labour market reports have put a June rate hike by the Fed back into the picture. This will allow the Fed to drop or dilute it reference about “patience” at its March meeting, which would lay the groundwork for an interest rate hike at its next meeting in June, which incidentally also includes a press conference. On the other hand, the Fed can certainly afford to remain patient before raising interest rates, given the global deflationary backdrop, the downward pull on inflation from low oil prices and the strong USD. But before we get to the next FOMC meeting on March 18th, the USD may come under pressure ahead of the release of the January FOMC minutes on February 19th and U.S. Federal Reserve Chair Janet Yellen’s semi-annual congressional testimony on monetary policy on February 24th.

 

Before we end this Dispatch, we would like to make two short points about the euro and CAD. The euro has been going back and forth within a 2 cent range on headlines about Greece and its solvency. One of our favorite sound bites this week came in an exchange with European Parliament President Martin Schulz and Greek finance minister Yanis Varoufakis. Schulz warned that Greece risks national bankruptcy if it continues down the path of non-agreement. Varoufakis’ response was to simply restate what he had previously said that Greece is already bankrupt. What you need to understand is that this is just plain old posturing and that the real negotiation will occur in the 11th hour. Greece needs about 10bln euros by the end of the month, but even this deadline may extend for another few months. Positive headlines will cause a short squeeze in the euro while negative headlines will cause the euro to sell off.