Euro buyers to emerge and accumulate dips

Outlook:

We like that St. Louis Fed Pres Bullard came right out and used the word “normalization” yesterday and called for it ASAP to avoid feeding asset bubbles and the need to raise rates more aggressively later, causing instability. Bullard told the FT waiting much longer risks ““devastating consequences.” Inflation is low chiefly because of oil and will return to higher levels as soon as the oil thingie is fixed. Okay, Bullard didn’t say thingie but he also didn’t offer any facts to support the idea of oil price stabilization, either. The important point is “Low inflation doesn’t rationalise policy rates of zero; it rationalises a policy rate below normal, but not zero.”

As for the bond market, central banks know how to manage those guys. Really? Bullard also dismissed the dollar and emerging market woes--the Fed has been talking about raising rates for such a long time, the effect should already be priced in. In any case, the US doesn’t adjust policy to suit others. “US monetary policy is designed for the domestic economy but we do look at all aspects of US growth and inflation, which includes emerging markets . . . I can’t believe [a rate rise] would be a shock for emerging markets.”

Vice Chairman Fischer at the Economic Club of New York also used the word “normalization.” He was speaking of the path of interest rates as unlikely to follow a smooth one-way trajectory because shocks happen—oil, geopolitical things, “budgetary and confidence implications,” even productivity. As a con-sequence, forward guidance is fading away because it’s unrealistic. “As monetary policy is normalised, interest rates will sometimes have to be increased, and sometimes decreased.” Well, since we are the zero bound now, don’t they have to go up in order for the Fed to be able to take them down if warrant-ed? And, oh yes, the dollar is strong because the US economy is strengthening and QE at the ECB is a good thing because it will promote growth and therefore US exports. Fischer said the Fed is on track to raise rates this year. That’s helpful, isn’t it? San Francisco Fed Williams was more specific. "I think that by mid-year it will be the time to have a discussion about starting to raise rates." Williams also cut his GDP forecast from just under 3% to 2.5%.

The analytical world is divided between those who see the Fed taking action in September and those who see it pushed out to December or beyond. A deciding factor is presumably CPI. We get the Feb numbers today, with the consensus forecast for core CPI at 1.6-1.7% y/y. The monthly is less interesting, probably 0.2% after a drop by 0.7% in Jan. We also get new home sales, probably a drop from 481 mil-lion in Jan to 465 million—and the Federal Housing Finance Agency house price index, but it’s for Jan and thus a bit out of date. On the whole, US data today is probably not a market-mover unless we get a surprise.

As we mention above, a new scenario for Greece is starting to emerge. Greece has dragged its heels for almost a month on delivering a new reform package, frittering away one of its precious four months. There has to be a reason for this delay. After meeting with Chancellor Merkel yesterday, PM Tsirpas is meeting with German Parliamentarians today. European Parliament President Schulz told an Italians newspaper “he expects a deal by the end of this week that will allow the release of at least some money,” according to Bloomberg.

Don’t hold your breath. Schulz is probably not in the loop, if our thesis is right that Greece plans to default, to demand re-financing, and to publish its own reform plan on its own terms, i.e., not subject to troika approval. Greece would keep the euro, too. The biggest problem in this scenario is that the troika would have to admit that it designed a bad plan for Greece that put all the emphasis on saving institutional investors from their bad decisions (trusting serial defaulter Greece to repay) and gave nothing but austerity and misery to Greek citizens. Tsirpas and Varoufakis want the troika to admit their mistake. It would be interesting to know how much Greece would give up to get that admission of error.

It’s interesting that we can see the train wreck coming and still not know how to trade it. Even Soros admitted to Bloomberg he doesn’t know how to trade it, although it’s obvious there are opportunities in the crisis. Soros sees the chance of Grexit as 50-50 and Greece could go “down the drain.” Soros called it a “lose-lose game” resulting from mismanagement by all the parties. Soros sees Greece leaving the EMU and has said so for over two years.

We expect the FX market to become more volatile, not less, because everybody and his brother is suddenly interested in participating in this best-performing “asset class.” Oh, dear. The WSJ has a story on various state pension funds—Florida, California, Connecticut—moving to an active FX strategy from a passive one, and running out to hire FX managers. Golly, did they not read the John Taylor FX Concepts story?

This will end in tears. Hardly anyone has the guts to point out that over 90% of all FX trading is purely speculative proprietary trading by big banks and other big institutions. It’s often coincidental that the outcomes seem to line up with Big Picture macro analysis. Consider the current situation. The logic is impeccable that the US and ECB have divergent policies that should favor the dollar. But the dollar has fallen over 5¢ since March 15 (low at 1.0452 to over 1.1000 this morning). There is no Big Picture macro justification for that—just the crowd correcting what now looks like an overshoot. Who is to say 1.1000 is also not an overshoot? Even the big boys don’t know whether to forecast 80¢ or $1.20 for year-end—we have both forecasts today. And don’t even think of “fair value.” It’s bunk in equity analysis and doesn’t exist in currencies, although some analysts have tried to create it.

So, we know there will be FX crises because that’s what always happens when big amateurs join the game. This is not to say the professionals are out to hose the newbies, although that is often true in the case of the retail saps. But it is to say the wolves are licking their chops at the door.

As for forecasting the euro for the rest of this week, we have to go with the flow, but acknowledge that the last high and 62% Fib level are serious danger points where many will take profit. Still, we expect euro buyers to emerge gain on dips. Probably the only thing resembling a sure thing out there now is the euro against the pound. We have some green shoots in Europe and a risk of deflationary recession in the UK. It’s an easy choice which to bet on.