Gold is already up 6.8% so far this year from the 13% slump in Q4

Outlook:

We keep expecting the dollar to resume its rally, underpinned by good funda-mentals and the Trump trade, but we keep not getting it—for an entire month. At the moment the focus is on a dovish (or laggardly) Fed. We think the Fed might be about to become irrele-vant. Two regional Fed presidents said Friday that three hikes this year are in the cards and March would be okay, too—but the dollar fell anyway.

First up was Chicago Fed Pres Evans (voter), who said he could be comfortable with three hikes this year, although at the Dec FOMC policy meeting he favored two. Evans is considered a dove and he raised his forecast explicitly on expectations for fiscal stimulus, although of course we need more de-tails.

Some reports got it wrong (EconoTimes), saying Evans sees the fiscal boost to growth but more im-portant is that he is a dove and prefers gradualism. The report says Evans' comments were a trigger for the dollar to fall in the Friday afternoon. To be fair, Evans did also say "I believe that appropriate poli-cy calls for a slow pace of normalization in order to give the real economy an adequate growth buffer to withstand downside shocks that might otherwise drive us back down" to a zero interest rate, according to Bloomberg. The Evans interview was published by Bloomberg at 9:15 am Friday morning.

To be sure, the dollar peaked on the high payrolls number very quickly and started falling around 11 am, but because of the lousy wage component, not because Evans is a dove or a gradualist.

A little later on Friday (after 1 pm), San Francisco Fed Pres Williams (non-voter) told Bloomberg that a March hike might be okay. "From a risk management point of view, there's an argument to move soon-er, rather than wait.... Three rate increases, like I said, it's a reasonable guess, a reasonable perspective to have as a base case. But honestly, I think there's a lot of potential that this economy is going to per-haps get more of a boost than the base case." At the same time, "there could be arguments for ‘caution' that would support holding off in March and waiting to collect more information."

Bloomberg notes that two Feds supporting three hikes and maybe even in March failed to impress. "Investors trimmed bets on a rate rise at the March 14-15 Fed meeting to a probability of 26 percent, versus 32 percent seen Thursday, after the weak wage data. That retraced to 28 percent after Williams' and Evans' comments, and investors see a 70 percent chance of a move by the June meeting."

Huh? The probability of a March hike rose a lousy 2 points after two Feds said March might be okay and three hikes instead of two is likely. FX traders heard the two Feds, but are placing a higher value on the core economics of the thing than on Fed remarks—they focused on wage growth being lousy. We have only one more payrolls report before the March meeting. It would take a lot to raise the chances of a hike in March. This is a sane and sensible deduction. And it shows that data trumps com-ments even from big shots.

Why are we nitpicking? Accuracy in reporting is important. EconoTimes reported the dollar fell on re-marks by a Fed. Not so. It fell on specific data and easily understood deductions from the data. Let's hope editorial writers and Mr. Trump don't read EconoTimes and take off after Evans in a tweet-storm. Be careful what you read.

Market News, the gold standard for accurate and careful reporting on FX matters, notes that the "market focus was mainly on average hourly earnings which rose a meager 0.1% in January, below MNI's median of +0.3%. In addition, AHE in December was revised lower to 0.2% from 0.4%, accord-ing to the Bureau of Labor Statistics." Economists noted job gains were widely spread among indus-tries and sectors, but U6 did rise to a 3-month high. This means there is indeed slack in the labor mar-ket. This is "ammo" for doves, says one. And lousy wage data is "baffling" in the context of seventeen states raising the minimum wage, especially because Jan was a short-day month. All the top-drawer economists interviewed by Market News express the view that the report gives the Fed no "reason to hit the brakes preemptively while waiting for more clarity on fiscal policy."

We might get a less pessimistic view from the Labor Market Conditions index today and JOLTS report tomorrow, but the big news is out. We don't expect a do-over.

And let's not forget the Fed has a dual mandate—boost employment (job done) and control inflation. It has been strange for the Fed to be rooting for inflation and managing it upward instead of downward, since deflation is such a rare occurrence. And the Fed still does not have the inflation rates it needs to do the deed—raise rates in March. The consensus of June at the earliest is almost certainly correct un-less something wild and woolly occurs. The Fed's preferred measure, PCE, was only 1.62% at end-December. The core PCE is 1.70%. Are those scary numbers? See the chart. The answer has to be "No."

But it's not current inflation that counts to market players. It's expected inflation. Some analysts like the 5-year breakeven rate, which is the regular 5-year minus the 5-year TIPS. Sure enough, it rose over 1.90% on Jan 24 and was quoted at 1.93% on Friday. But for the two months before then, it was 1.74-1.90%. In other words, the rise is relatively new. The 10-year breakeven rate is over 2% and has been holding there for a month, but that is relatively new, too. See the chart from the St. Louis Fed (next page).

All this tap-dancing about various bits of data and Fed stances leave us with the expectation that we can't count on the Fed to provide a dollar-boosting rate hike in any timeframe that counts right now. The June FOMC is a million miles away. We will probably get those supposedly dollar-boosting tax and fiscal initiatives before then, re-igniting the Trump trade and rendering the Fed.... irrelevant.

What a thought.

Besides, the euro is getting—and deserves—some tailwind from its own inflation and QE situation. Eurozone inflation is 1.8% at the last measurement, close to the 2% universal central bank benchmark and higher than the US. Meanwhile, the ECB is clinging to QE and Mr. Draghi claims the policy com-mittee is not even talking about tapering. He speaks to the European Parliament today and will have to dance pretty hard to defend the position that inflation has to persist over the medium term (and not just one month of data), and be proven to be durable, stable, self-sustaining, and broad-based. Golly, that covers the waterfront. Bloomberg notes that last week, board member Benoit said "We do not react to short-term fluctuations, particularly those caused by energy and other commodity prices. The core of our analysis will be ‘is this higher inflation sustainable?' The conclusion today is: no."

So here we have two major central banks both behaving dovishly while inflation rises, if not impres-sively, in the background. Who blinks first? If we say the Fed is irrelevant because it will be trumped by Trump, then the ECB counts more heavily. The prospect of tapering is euro-favorable.

Here's a politics-driven forecast—inflation is a good enough excuse for gold bugs, but Trump's "mistakes" are even better. David Roche, a long-time market observer, told Bloomberg gold will rise about 6% this year to $1300 on a safe-haven flight from the political risk being created by Trump. We will probably get a trade war with China, for example. Gold is already up 6.8% so far this year from the 13% slump in Q4. And it's up today by 0.5% to $1,226.19 an ounce by 11:45 a.m. in London. The Fed can go ahead and raise rates three times. So what? Political risk will outweigh and "lure investors to gold." See the chart on the next page.

UBS agrees with Roche, although National Australia Bank and BNP Paribas think rising interest rates will win, lifting the dollar and pushing gold down toward $1,000. Place your bets here.

Politics: Words count. What we have now is a "restraining order" against the President of the United States or rather his executive order that is widely perceived as an unconstitutional religious ban. It's a temporary order and we will get another judgment today, but pay attention to that word "restraining." The president needs to be restrained, implying he was reckless and careless. Trump in-sulted the judiciary (again) by calling the judge who issued the retraining order a "so-called" judge, causing the Sunday TV talkers to bemoan his authoritarian streak but also to celebrate that the US sys-tem of checks and balances is working.

Tidbit 1: More than one advisor likes the EUR/JPY as a bolthole from Trumpism. The idea is that cutting the dollar out of the equation means outrageous Trumpian comments that affect the euro or the yen will not affect the cross-rate. Really? Is that how it works? If Trump says something scary (and false) about Japan manipulating the yen and threatens a trade war over previously made "bad deals," the yen slips downward as the risk-averse seek the safe-haven of home.... from all corners, not just from the dollar. The CFTC Commitments of Traders report shows the yen net shorts at the lowest since early December.

As we noted last week, the new signal short EUR/JPY is very weak. Here is another view of it.

To be sure, the current price level is quite far from the 200-day moving average at 118.15. That level in turn is quite close the 50% retracement of the move up from September. Before we can feel confident about the sell signal, we really need to see the price match-and-surpass the previous low, 120.54 from Jan 17, and even that is not a surefire sign. Whether this new move persists and morphs into a full-bore corrective retracement depends on how Trump behaves in the meeting with Japanese PM Abe and his team on Friday (Feb 10). Expecting Trump to change his tune is the triumph of hope over expe-rience.

Besides, take a look at the weekly chart. We see a downward trend forming. In this context, it's the up-move that is corrective. The latest highest high fails to come close to the previous one (128.22 from the last week of March 2016). If the primary trend downward resumes, we are more likely to see a test of the last lowest low, 109.54 from the week of June 20, 1026, than a test of that last high.

Tidbit 2: About that 35% corporate tax rate. Nobody pays it. Quartz writes that "the average effective corporate tax rate in the US from 2007 to 2011 was 22%. Indeed, even though corporate prof-its have reached record highs, the amount of revenue generated by the US corporate income tax has fallen steadily in recent years."

The Republican "Better Way" plan is to replace the 35% income tax with a 20% "destination-based cash flow tax with border adjustments." Yikes. It sounds complicated and it is. Quartz has the first coherent explanation of the scheme.

The article starts with cash flow. Focusing on cash flow instead of income gets rid of all those games that hide income, like deferred foreign income, inter-company transfers, and exaggerated depreciation schedules and inventory valuation, etc. New debt would be treated as cash-in, although interest pay-ments would be cash-out and deductible. Wages would be cash-out, too. "Economists consider this levy on corporate cash flow a consumption tax, because it falls on what consumers are ostensibly paying the company for—the value they add to their products, less the cost of the raw materials to purchase them."

Don't forget that VAT is regressive—it falls more heavily on poor people, although the deductibility of cash wages might offset.

The destination-based part of the Plub plan means foreign-generated revenue would escape all US taxa-tion. No more Sub-part F (yes, it still exists). Companies would have a giant incentive to move every-thing offshore, including (especially) intellectual property. Sell Microsoft Office from Ireland to Spain—no US tax on a quintessential American company whose intellectual property arose in the US. Here comes the border adjustment. A US company can't deduct the cash cost of imported goods or components, and it pays a 20% tax on them. The non-deductibility and 20% tax would apply to big im-porters of raw material, like (say) Koch Industry's imports of tar sand crude from Canada. No wonder Koch opposes the plan.

Re-directing purchases to domestic suppliers and emphasizing exports should drive the dollar up. An-ticipation of the change will drive it up ahead of time. And the designers of the new tax are counting on a stronger dollar to make it work. This is a very scary thought. "If the dollar's value increases com-mensurately with the tax, by 20%, the extra cost of the companies' imports will be washed out in the company's after-tax income by the additional profits. But if the dollar doesn't behave as expected, the change in plans will mean a big new tax burden for American importers."

If the dollar appreciates by the amount of the tax, "the tax plan's biggest academic backers insist it won't affect the US trade balance at all." Really? Is that how the world works?

Critics say that counting on the dollar to make a tax work is stupid. Peterson Institute chief Posen says international trade accounts to only 5-10% of total FX turnover. "The idea that this trade adjust-ment is going to have any major effect on the currency is crazy. And if the currency doesn't appreciate, this is a total attack on the rest of the world."

Another major concern is its effect on the deficit. Supposedly it "will cut corporate taxes by $900 bil-lion over 10 years, which leaves a huge gap for growth to make up. More likely, the deficit will be cov-ered through borrowing." And here's a juicy one: refunds forever. Produce in the US and sell abroad, and pay no tax—and be entitled to a refund.

So far the new tax plan is a set of ideas and academic papers, not proposed legislation. But stay tuned.

		Current	Signal	Signal	Signal
Currency	Spot	Position	Strength	Date	Rate	Gain/Loss
USD/JPY	112.57	SHORT USD	WEAK	01/05/17	115.93	2.90%
GBP/USD	1.2479	LONG GBP	WEAK	01/24/17	1.2451	0.22%
EUR/USD	1.0738	LONG EURO	WEAK	01/10/17	1.0587	1.43%
EUR/JPY	120.87	SHORT EURO	WEAK	02/03/17	121.56	0.57%
EUR/GBP	0.8605	LONG EURO	NEW*WEAK	02/06/17	0.8605	0.00%
USD/CHF	0.9955	SHORT USD	WEAK	01/05/17	1.0113	1.56%
USD/CAD	1.3016	SHORT USD	WEAK	01/05/17	1.3253	1.79%
NZD/USD	0.7307	LONG NZD	STRONG	01/10/17	0.7014	4.18%
AUD/USD	0.7657	LONG AUD	WEAK	01/05/17	0.7343	4.28%
AUD/JPY	86.19	LONG AUD	STRONG	10/06/16	78.48	9.82%
USD/MXN	20.3638	SHORT USD	WEAK	01/31/17	20.8108	2.15%