Strategic Currency Briefing

Outlook:

The one data release in the US today is new home sales, with Case-Shiller tomor-row, mortgage applications on Wednesday and pending home sales on Thursday. The Bloomberg survey has a forecast for new home sales up at 429,000 annualized in July from 406,000 in June. We also get the revision to GDP on Thursday. Friday brings personal income and the Chicago PMI, but by then the market will as thin as Wallis Simpson.

The main take-away from Jackson Hole is that the Fed is going to complete tapering in October on schedule and then we all have to wait for the details of employment to suit Yellen. This puts the First Rate Hike in the summer of next year, according to Atlanta Fed Lockhart and San Francisco Fed Williams. Philly Fed Plosser wants it faster, but Yellen, wearing her economist’s hat, says the details and nuances of the jobs data doesn’t support a hike.

Meanwhile, Mr. Draghi was wearing his pinko hat and called for member nations to boost both supply and demand while neglecting, for the moment, budget deficit limits. If the June initiatives fail to work—and they don’t come into action until October and need to be given some months, since they will work only with a lag—and if new member initiatives also fail, then it will be time to speak of QE. Many observers think Draghi promised QE, but this is not accurate. The “promise” contains those two qualifiers and will be much delayed while other developments are being watched, like the bank asset quality and stress tests.

An FT editorial says “The eurozone is sliding towards deflation and its main economies stalling, yet the ECB continues to ask for more time to study the effect of purchasing assets outright. Its failure to act earlier means it will have to do more later. It is quite possible that the Fed’s planned exit from QE in October will coincide with the ECB being forced to start.” This is not correct. It’s a long haul for QE will come back as a real possibility, probably late in Q1 of next year. To say the ECB will start QE in October as the Fed is ending it is just plain wrong.

We may complain with the FT that the ECB drags its heels, but it’s important to note that heel-dragging is the nature of the beast. Draghi has a gaggle of members to herd together, a far harder job than Yellen’s herding of the regional Feds. The regional hawks like Philadelphia’s Plosser are far less scary and powerful than the Bundesbank. It’s more than a difference of scale—Philadelphia is not a sovereign. And remember that at the height of the financial crisis, Germany was the leader in seeking a balanced budget and cutting deficits. From a Keynesian point of view, this was stunningly wrong. Draghi’s call for fiscal stimulus on both the demand side and the supply side runs directly counter to the German mindset. It’s almost as though Draghi is offering Germany a trade-off—relax austerity and you won’t have to deal with QE.

Given all these modifications and qualifications, the fact remains that the US is on the road to recovery and to “normalization” away from zero rates, while Europe is mired in stagnation and deflationary tendencies that are about to get a whole lot worse when the Russian sanctions start biting exporters. Some modest tightening is due within the year in the US and some loosening is due within the same year in Europe, depending on how each member responds to Draghi’s leadership. Overall, the implication is that the euro should fall and the dollar should rise. We have no idea where the UK stands in all this. The assumption all along is that the UK will lead, but the BoE is being coy and don’t neglect to notice that financial stability is a bigger issue in the UK than in the US, the Fed’s Vice Chairman Fisher having been silenced on that point. As for the dollar/yen, Kuroda bravely said the current level of yields at about 0.50% will not last much longer, but he is spitting in the wind.

The problem, of course, is that dollar rallies seem not to last long and the historically persistent anti-dollar bias needs only the faintest of excuses to rear its ugly head. When the euro stops at its next congestion/consolidation point, assumed to be about 1.3150, we wonder what the story will be… possibly the need for the US to blow whatever budget constraints it has managed to get on more Defense Dept spending. Nobody ever said economic affairs are fair.

Note to Readers: We will take off next Thursday and Friday, Aug 28 and 29. These dates precede Labor Day on Monday, Sept 1, which is a national holiday in the US. There will be no reports on Thurs-day, Friday or Monday. We return Tuesday, Sept 2.