Why is the Fed not chiding the market for keeping long rates so low?

Outlook:

We get the Kansas City Fed survey today, of more interest than usual after the Philly Fed doubled yesterday (and some sourpusses blamed a statistical error). Ahead of the US holiday week next week—we close early on Wednesday, Thursday is the holiday and most people take Friday off—we have a ton of material to digest. How to organize it?

First, the good US data yesterday failed to propel yields higher, as it “should” have. This reminds us that there is a great divide between what the Fed is saying—First Rate Hike in mid-2015—and what the bond market believes—no rate hike until long after that, maybe year-end-2015. We wrote yesterday that this is a big problem, and yet a mismatch between the market and the Fed is actually quite common. Remem-ber the Greenspan surprise in 1994? It literally ruined some firms. That ended, probably, the Fed’s prac-tice of surprising the market and was the start of the move within the Fed toward greater transparency. We say that two decades later, transparency is still badly lacking.

Why is the Fed not chiding the market for keeping long rates so low? Well, long rates are good for busi-ness, especially housing, and housing is a big deal to the consumer. But Plosser is right. By letting the market defer a rise in long-term rates, the Fed is risking the need for a sharper rise in short-term ones. Evidently Plosser thinks the Fed should start selling. Market News notes that the recent high in the 10-year was 2.655% from Sept 19, and that was the highest since July. Bottom line—the trajectory is point-ing the wrong way. There is a potential crisis in here.

A second important point is another old one—the power of verbal intervention. Recently we have seen it most flagrantly in the AUD, but the Japanese are the masters. For the FinMin to complain about the pace of yen depreciation, and to get the knee-jerk response, was excellent timing—just ahead of the much-named natural target of 120. And never mind that other government officials have been calm about the depreciation. Aso is The Man and gets the headlines.

Mr. Draghi had to know the effect his comments would have, too. He was speaking at a Frankfurt banking conference, but everyone follows every word however dull the venue. And Draghi didn’t say anything much new, either. You have to wonder if a staffer showed him a chart like ours indicating a breakout above the channel. Draghi admits he wants a lower euro. “There is evidence that both the vari-ous large-scale asset purchase programmes of the Fed as well as the Bank of Japan’s quantitative and qualitative easing programme led to a significant depreciation of their respective exchange rates, even in a situation in which long-term yields were already very low, as in Japan.”

As noted before, a weak euro has as much power (or more) to stimulate economies as central bank asset-buying. This time Draghi added a free-market incentive—as the FT reports, “In one of the strongest de-fences of bond buying yet, Mr Draghi said purchases of government debt would help increase prices for riskier assets, which in turn would ‘free up capital resources for additional lending’” as well as improve household balance sheets. The FT deduces that bond-buying will begin early in the new year, although the actual statement doesn’t name a date. This comes from the statement that action needs to be taken “without delay.” Draghi said “If, on its current trajectory, our policy is not effective enough to achieve this or further risks to the inflation outlook materialise, we would step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our purchases.”

At a guess at a timeline, we wait for the next eurozone inflation rate and another speech by Draghi say-ing whether he thinks it qualifies to stay the ECB’s hand. In a way, Draghi was throwing down the gauntlet to the BBK. So far we have no direct response from Mr .Weidmann, whose opposition to sover-eign QE is well-known. Remember, too, that earlier Draghi was hinting that we should wait for the ex-isting programs to kick in. Now he is drawing a line, even if we don’t really know where it lies. We may as well accept the FT’s judgment of early in Q1. The ECB website has the next monetary policy meeting of the governing council on Dec 4 and after that, Jan 22 (there is a meeting on Jan 7 but it’s labelled “non-monetary policy”).

We wanted a catalyst to re-boot the positioning and it looks like we have it in the form of the Draghi gauntlet. If the euro continues in a normal chart pattern, it should hit the linear regression around 1.2382 in the next day or two and 1.2238, the channel bottom, early next week. Two caveats—currencies are not physical objects that obey statistical rules, and even when they do, a touch of the bottom channel implies a corrective bounce, sometimes all the way to the channel top again. Still, the overall direction is downward so that’s the way to bet. But it’s a euro rout, not a dollar rally—not until yields start providing real support.

Note to Readers: Next Thursday (Nov 27) is Thanksgiving in the US, a national holiday (that pur-ports to celebrate the Indians helping out the Pilgrims with food and look how we are repaying them, a disgrace on a par with slavery). We will not publish any reports on Thursday and only the traders’ re-ports on Friday.