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.

 

 

 

Patience is out the window

Last week the US Federal Reserve removed the word "patience" from their statement with regards to interest rate hikes in the future indicating that they may raise rates sooner than expected. However, they also leave in caveat to further evaluate the economic conditions that let that guide their policy "Even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run."

Since the announcement the US dollar has lost 2-3% against many of the major currencies contrary the fact the interest rates may rise. What does this mean? Has the market lost faith in the FED guiding policy to an improved economy? One interesting thing to consider is that 90% of the economists surveyed by Bloomberg assumed that the FED would remove "patience" from their policy. So, even though the consensus anticipated the change, the currency market still had some of the most volatility since the "fat finger" flash crash in 2010. Furthermore, much of the fundamental economic data out of the United States is more promising that many of the major currencies that it lost ground to.

 

 

 

EUR/USD finally had some relief from the free fall of the last few months and hit a high of over 1.10 while settling back to 1.0650 before the week ended. The Yen dropped to a three week low at 119.80 while the USD/CHF fell almost 3% (0.9750). That said, the CHF has been so strong as of late, luxury Swiss watch marker Tag Heuer had to drop or freeze prices in many markets to help consumers endure the relative weakness of their currencies.

 

 

 

Up, Up and Away - USD was the top performer last week

 

 

 

The USD was the top performer last week thanks to Friday’s U.S. non-farm payroll and developments elsewhere. The global monetary easing parade continued last week with surprise interest rate cuts from the central banks of China, India and Poland. Not to be left out, the European Central Bank announced that it will begin buying bonds (QE) on March 9th. This reinforces the dominant factor behind USD strength, which is the divergent direction of monetary policy guidance from the Fed and the policy outlook for many other central banks.

 

However, the USD powered higher against a broad cross-section of other currencies after Friday’s non-farm payrolls report as market participants are convinced more than ever that the U.S. Federal Reserve will raise interest rates in June. The 1.5% fall in the Dow tells us that equity investors are also convinced that the Fed is going to hike rates and are expecting the Fed to drop the word "patience" from its forward guidance at the next FOMC meeting on March 18th.

But before we all take for granted that the Fed is going to hike rates in June let’s pretend that we are Fed economists. Any economist worth her pay will tell you the following: based on the relative strength of the U.S. economy the Fed is in a position to raise interest rates, but on the other hand. Oh yes, the famous other hand. To be fair that hand has been weighed down by multiple economic data points that have missed expectation since the beginning of February...

 

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.