High probability for a continuation of Euro upswing

Outlook:

We get the final Q4 GDP revision today (2.4% expected from 2.2%) plus consumer confidence, but of far greater interest is the gaggle of Fed speakers yesterday and today. Every word will be examined with a fine-tooth comb for hints about rate hike intentions. So far it looks like the majority is trying to rope the market into believing in September. This is the consensus, anyway, even if the forecast distribution curve has a fat tail.

Atlanta Fed Pres Lockhart said "I think the middle of the year, perhaps a little later, will turn out to be a reasonable timeframe…. "As far as I am prepared to go on the timing of a liftoff decision, whether it'd be June, July, September of later, is just to say I think it's likely in one of those meetings." This is interpreted as meaning not later than Sept, but Lockhart is dovish (and a voter).

Speaking in Frankfurt today, Vice Chairman Fischer said "At this stage of the recovery, there are signs of reduced nonbank financial sector vulnerabilities. The available data paint a picture of a nonbank sector that has generally reduced its vulnerability to the types of shocks that we saw during the crisis." The so-called nonbank financial sector is also called “shadow banking” and includes insurance companies, mutual funds, money market funds and hedge funds.

Chairwoman Yellen speaks late today (3:45 pm ET) on "The New Normal for Monetary Policy." Just about the only thing we can be sure of is that she will downplay forward guidance in the future, perhaps abandoning it altogether (as Fischer would prefer).

Both Bullard and Lockhart are promoting the idea that the Fed’s wobble at the March meeting was temporary and the Fed expects normalization to proceed starting in the June-Sept quarter. After all, at the time of the March FOMC, the euro was crashing and the ECB was just starting QE. For some reason, QE had not been fully built in as usual, and besides, everyone was deeply puzzled and worried about those negative yields. As when Bernanke delayed the taper, markets got confused. And oil was still falling like a rock. To a certain extent, the Fed was responding to then-current conditions that could have spiraled out of control. This gives us a clue—if conditions seem be normalizing, we can expect the Fed to normalize rates. Yellen’s speech is titled “the new normal,” which we hope is not a nod to Bill Gross, who invented the term a few years ago. It means permanently slower growth studded with recession/deflation.

Meanwhile, the new dollar rally faces some stiff headwinds. As noted above, foreigners are buying Eu-ropean commercial real estate at a sizzling pace, which is only to be expected when rates are low or negative. In addition, as Market News reports, German equities are up 21% and global flows into European equities generally is robust. “’With fears of a June hike in US interest rates receding and fears of a less-than-stellar 1Q15 US corporate earnings season moving to the fore, equity investors stepped up their recent push into Europe during the penultimate week of March,’ said Cameron Brandt, director of research at EPFR Global in his weekly, released Thursday.

"’Preliminary data based on combined daily and intraday data - which has a more than 90% correlation with the weekly numbers that will appear later today - suggests that EPFR Global-tracked Europe Equity Funds will set a weekly inflow record for the third time since mid-February and could see net flows for the seven days ending March 25 top the $6 billion mark.’

“Traders looked for these eurozone equity inflows to be largely FX hedged, which was why most market players still looked for the euro to test parity in sessions to come.”

Wow, that last sentence is a barn-burner. To factor in hedging of euro-denominated investments is quite a risk. After all, multinational corporations have skimped on hedging, hence the wailing and gnashing of teeth over earnings. The implication is that financial institutions making equity and other asset investments in Europe are smarter, and do hedge, although the commercial real estate investments are said to be unhedged.

So, whither the dollar? Let’s stick to principles. The technical analysis mantra is that a trend in place stays in place until Something Big comes along to disrupt it. We didn’t actually have Something Big yesterday. We certainly didn’t have any new perspective. The fixed income market had a short-lived and incomprehensible response to data or equities or whatever was floating its boat. When the Market News fixed income reporter resorts to making lists of possible reasons for price/yield moves, it means nobody knows what is going on. Equities are subject to their own hysterical responses to events, often completely unwarranted, and oil also had a freak-out yesterday over Yemen, of all things.

In other words, we can’t put a finger on a factor or set of factors that justifies a dollar rally or the end of the euro correction, so let’s not accept that idea just yet. To be fair, we do sometimes get a trend reversal on a factors we can’t identify at the time. But we should make decisions on high probabilities, not any old possibility. And right now, the probability is for a continuation of the euro upswing. Having said that, we may not get a higher high than yesterday’s 1.0896.

That leaves us in the soup for Sunday night. One camp is sure to imagine that failure to close the week over the highest high (1.1053) means the euro rally is over. We are not so sure. We hardly ever get a higher high on a Friday. At a guess, by the end of the day we will want to be square and stay square, and give ourselves the weekend to digest Yellen. We may also want to mull over the month and quarter-end. Sometimes these count and sometimes they don’t. This time, if we have a possibility of a rate hike by the end of the coming quarter, the quarter-end prices and positions may count.