USD vulnerable to pullbacks until yield scenario clears

Outlook:

Today’s calendar includes initial jobless claims, the flash manufacturing PMI, and new home sales. To the degree that yesterday’s excellent existing home sales steadied the bond gang, another good data set from housing could be just the ticket. But even so, the 10-year is altogether too jumpy. We never know when to expect a yield dip to 1.75% or when we will finally get a lasting and sustainable rise over 2%. The dollar is vulnerable to pullbacks until the yield scenario is both clearer and more universally accepted. Obviously it’s not enough that the Fed has a tightening bias.

In an effort to link economic performance and sentiment at the Fed, the WSJ notes that we do indeed have a seasonality effect at work. “There’s a good deal of talk these days about the seasonality of post-crisis economic patterns. The first quarter seems to be a perpetual disappointment. As researchers at the Federal Reserve Bank of Atlanta’s Macroblog pointed out last week, output in the first quarter has grown at a 0.6% average rate during the past five years, compared to a 2.9% average during the remaining three quarters of the year. It is a development that has gotten the attention of senior officials.”

And the Fed shows seasonality, too (!). “Many of the Fed’s biggest decisions since the 2007-2009 crisis have happened between the months of August and December. The Fed’s second bond-buying program (QE2) was launched in November 2010. Interest rate guidance tied to calendar dates was launched in August 2011. A program to extend the maturity of its bond holdings, known as Operation Twist, was launched in September 2011. The third bond-buying program (QE3) set sail in September 2012. Economic thresholds meant to guide interest rate decisions were introduced in December 2012. QE3 was also expanded that month. The Fed decided to taper its bond purchases in December 2013. It ended bond purchases in October 2014. Then it shifted its interest rate guidance away from assurances of low rates for a considerable period in December 2014.

“This might all be coincidence, or there might be a broader pattern setting in. Fed officials do seem to be spending a good part of the first half of the year trying to figure out if their economic forecasts are holding up to the stream of incoming economic data. It might be the case that it takes several months to assess the accuracy of annual forecasts and formulate responses as the outlook shifts.

“If the pattern holds, then the Fed’s call on raising short-term interest rates is still several months away…. Maybe we should all take off until August.”

Funny—we agree. It might be August before we have any sense of certainty about anything, not only the Fed but also the Greece situation and whether contagion appears. So far we are not getting the same effect as in the 2012 crisis, when peripheral yields went through the roof. The ECB itself does not detect undue systemic stress—see the FT’s chart. As we warned yesterday, we can have a prolonged period lasting months of sideways ranging, if in a wider range than we have today. And when we get these prolonged range-trading periods, they tend to come in the spring and summer. The years 2004 and 2006 are good examples.

That doesn’t mean the fundamentals don’t count. It does mean you can’t count on the fundamentals in any particular trading situation, especially if the market has extended positions and gets in the mood to dump them. Since we lack data on trading volumes in spot FX, detecting sentiment is exceptionally hard. Be careful.