Outlook:

The other day, Fed Gov Brainard voiced a dovish position because “the underly-ing momentum of the domestic economy is not strong enough to resist the deflationary pull of the international environment.” US growth will decelerate if global growth keeps slowing and the dollar keep firming. Then “progress toward full employment and 2% inflation would stall or re-verse.”

Nonsense. We were all sold a bill of goods, the idea that because information flow is so fast and global that actual trade in goods and services must have expanded proportionately. It’s not so, at least not for the US. Total foreign merchandise trade in the US remains at about 20% of GDP. And here’s an interest-ing fact: if you search for “trade as percentage of GDP,” you get badly presented and outdated infor-mation.

You’d think any economist worth his salt would have that one number at his fingertips, but in practice we do not and getting a decent update is very, very hard. We finally found a world chart of trade as per-centage of GDP at the OECD and it shows the US at the extreme far end, with the lowest number. The chart also says data is as of 2010 or whatever’s latest. This is simply not acceptable. Every developed country reports trade data monthly. To get 2010 data—or data of an unknown date--in Q4 2015 means the OECD is not doing its job. Nobody else is, either. How hard can it be to divide one number by an-other?

For what it’s worth, the OECD chart shows the US with exports + imports at about 20% of GDP and for Germany, the two combined are about 80%. This has not changed much over the many decades we have followed the data. Okay, falling exports are a drag on GDP. But not a game-changer, at least not in com-parison to other countries.

Bottom line: Brainard is talking through her hat. The US is not the one that’s vulnerable to slowing glob-al growth or deflation. To postpone a rate hike on the grounds of a possible future contagion that would affect only a tiny fraction of overall GDP is not sound analysis.

Besides, the real cause of low inflation in the US is not lack of demand for US exports, but oil prices. The price of crude has fallen about 50%, with the effect permeating everywhere. Nobody in his right mind thinks we can get another 50% drop. To be sure, analysts make the case for $20 (Goldman) and also $70 (UBS), and both scenarios are fascinating to read, but the crux of the matter is that in the next few months, the data will start showing an end to falling oil prices on the year-over-year basis.

It’s frustrating that the Fed fails to focus on the centrality of oil prices. Ex-energy, US inflation data is not all that bad, up 1.8% y/y. Equally important, the number has been stable for several years. The ser-vices component is also steady at about 2.6% every year for the past three years. As the WSJ writes, “Services are largely isolated from the impact of global demand or of the strengthening dollar, since they aren’t widely traded across borders. Health-care prices (up 2.5% in the past year) aren’t subject to the whims of global demand, and neither are shelter prices (up 3.1%).”

Moreover, “current trends in U.S. prices aren’t ringing alarm bells. Even with falling prices for manufac-tured goods and raw materials, 75% of the money consumers spend each month goes for items with ris-ing prices. Inflation is already too low, no question. But it doesn’t seem to be heading any lower.”

Strategic Currency Briefing

Let’s say this is a sane and reasonable interpretation. It means fear of global disinflation is a false as-sumption. Traders who freak out over low retail sales or low inflation data are not observing their own behavior and their own experience with real-world prices, but rather buying into an unwarranted near-panic in financial prices. Well, it’s certainly not the first time traders are divorced from reality or fail at reality-checks, but it’s an especially pernicious one this time because it’s a bit more nuanced and be-cause fighting the crowd’s interpretations could be costly. It’s easier and more profitable to go along with the crowd, even when the crowd is simply factually wrong.

We blame the Fed. Yesterday the odds of the Dec hike went to 27% from 35% the day before. The odds for Jan are now 36% and 48% in March, according to CME data reported by the WSJ. And yet Yellen has uttered nary a word about what we can and should expect. To the factors contributing to the negative dollar outlook, we must put “lack of clarity from the Fed” at the top of the list. We are not alone. The head of BlackRock told the FT that “mixed messages” from officials were contributing to volatility and “inflaming the markets.”

But here’s the scary part: we may scorn the Chicken Littles running around saying “the sky is falling, the sky is falling” but there is an element of self-fulfilling prophecy to these sentiment developments. Never mind that we are a long way from the 2008 crisis. As noted above, Market News writes “Many investors see the 10-year Treasury yield being trapped below 2.5% for the balance of the year. The yield was 2.173% at the end of 2014 and 3.03% at the end of 2013. It is less than half of the level it had traded at before the 2008 financial crisis.” How can we have almost full recovery from the crisis and yields be lower for a third year? There’s something terribly wrong here. We say it’s failure to launch normaliza-tion. Tell people they are sick and they start feeling sick. Tell people their recovery is wonderful and they start feeling good. It’s that simple.

What this means for the dollar is relentless selling… until the selling gets overdone. FX markets always overshoot and the core cause of overshooting is interest rate expectations, One potential trigger to identify overshooting might come at the Oct 22 ECB policy meeting, but don’t count on it. Draghi keeps saying the ECB has plenty of tools and opportunities to be flexible, but to extrapolate that into an expansion or prolonging of QE is to make raw guesses. So, we are sticking to our forecast of 1.1700 and PDQ.

Strategic Currency Briefing

CurrentSignalSignalSignal
CurrencySpotPositionStrengthDateRateGain/Loss
USD/JPY118.41SHORT USDNEW*STRONG10/15/15118.410.00%
GBP/USD1.5489LONG GBPWEAK10/08/151.53460.93%
EUR/USD1.1443LONG EURSTRONG09/29/151.12261.93%
EUR/JPY135.50LONG EUROSTRONG10/13/15136.32-0.60%
EUR/GBP0.7388LONG EUROSTRONG08/13/150.71173.81%
USD/CHF0.9498SHORT USDSTRONG10/09/150.96121.19%
USD/CAD1.2896SHORT USDSTRONG10/06/151.30821.42%
NZD/USD0.6869LONG NZDSTRONG10/05/150.65235.30%
AUD/USD0.7340LONG AUDSTRONG10/07/150.72061.86%
AUD/JPY86.91LONG AUDSTRONG10/08/1586.060.99%
USD/MXN16.4038SHORT USDWEAK10/08/1516.62831.35%

This morning FX briefing is an information service, not a trading system. All trade recommendations are included in the afternoon report.

Recommended Content


Recommended Content

Editors’ Picks

AUD/USD holds above 0.6500 in thin trading

AUD/USD holds above 0.6500 in thin trading

The Australian Dollar managed to recover ground against its American rival after AUD/USD fell to 0.6484. The upbeat tone of Wall Street underpinned the Aussie despite broad US Dollar strength and tepid Australian data.

AUD/USD News

EUR/USD comfortable below 1.0800 lower lows at sight

EUR/USD comfortable below 1.0800 lower lows at sight

The EUR/USD pair lost ground on Thursday and settled near a fresh March low of 1.0774. Strong US data and hawkish Fed speakers comments lead the way ahead of the release of the US PCE Price Index on Friday.

EUR/USD News

Gold pulls away from daily highs, holds above $2,200

Gold pulls away from daily highs, holds above $2,200

Gold retreats from daily highs but holds comfortably above $2,200 in the American session on Thursday. The benchmark 10-year US Treasury bond yield stays near 4.2% after upbeat US data and makes it difficult for XAU/USD to gather further bullish momentum.

Gold News

Google starts indexing Bitcoin addresses

Google starts indexing Bitcoin addresses

Bitcoin address data is live on Google search results after users realized on Thursday that the tech giant started indexing Bitcoin blockchain data. However, mixed reactions have followed the tech giant's reversed stance on the cryptocurrency.

Read more

A Hollywood ending for fourth quarter GDP

A Hollywood ending for fourth quarter GDP

The latest revisions put Q4 GDP at 3.4%, the second fastest quarterly growth rate in two years. Much of the upside was attributable to stronger consumer spending, yet fresh profits data affirmed it was a good quarter for the bottom line as well with profits up by the most since the Q2-2022.

Read more

Majors

Cryptocurrencies

Signatures