The US economy seems in fine fettle

Outlook:

The US economy seems in fine fettle and the markets are less willing than ever to heed Washington nonsense. In late December, when everyone was fretting about the fiscal cliff, the sequester talk had some real weight. Nowadays, we don’t want to hear about it. So it will raise unemployment and cut growth by 0.5%--who cares? The effort to think about it has no payback, so we have stopped thinking about it. 

Next week (Feb 28) we get another revision to Q4 GDP, probably a rise to 0.5% from -0.1%, according to Bloomberg. That’s plenty to overcome the March 1 sequester. The day before, though, we get durables, probably a drop for the first time since August. Anyone who sees a change in Fed policy from this data is dreaming. It will take payrolls to inspire new Fed talk… if we are reading the Labor Dept website right, we get payrolls not on Friday, March 1 but the following Friday, March 8. We have had bad weather so the results might be disappointing. Bottom line—unless and until economic data, especially job creation, rises to “escape velocity,” the Fed will sit on its hands. That doesn’t mean all talk of ending QE will just fade away. We are probably in for more FX and stock market gyrations as the next chapter emerges, but while it can hard to do, remember words are not actions. Real action from the Fed is still unlikely in the extreme. 

The Italian election this weekend gets a lot of attention in Europe (especially Germany) and almost none in the US. But it could have important implications for the eurozone, specifically whether peripheral countries take Draghi’s advice and pull up their socks. Draghi has basically adopted the German approach—government should work with the unions to obtain competitiveness, with unions sacrificing wages and benefits in return for job-sharing and other stability measures. Current PM Monti concurs—well, he’s an economist. It’s trouble-maker Berlusconi who likes to stir up unrest, with the ex-Commie Bersani seemingly reformed but unable to win on his own and probably forming a coalition with Monti’s party. According to a source in Germany, Italian polls are terribly inaccurate and about 20% say they are “undecided.” Aside from Berlusconi, one of the candidates is a comedian who wants a referendum on staying in the eurozone. In a word, messy. We don’t get exit poll information until late Monday and the final outcome on Tuesday. It’s possible that fear of a bad outcome (anything other than a Bersani-Monti coalition) could do some real harm to the euro. 

So, whither the dollar? We are always suspicious of a rise in the dollar that is not well-founded, and we worry about the euro being able to shrug off any amount of bad news that would fell a lesser currency. The world craves higher yields and is willing to take risk to get it. That still excludes the US. The euro has already retraced more than 62% of the upmove this year, implying a test of the last major low (1.2994 from Jan 4), but we don’t buy magic numbers. What timeframe is the right one, anyway? If we widen the chart to last July 24, the low was 1.2043, and the 38% Fib retracement on that scale falls at 1.3087. That number has a better smell as a maximum move this time. In other words, we may have a system sell signal, but we don’t trust it yet, and we always worry about a euro downmove on a Friday—traders will want to take profit and pare positions, Italian election notwithstanding.