Inflation remains well over the Fed’s 2% target

Outlook

The news today includes the ISM service sector and the ADP private sector jobs report. The partial government shutdown is preventing the payrolls report so again analysts will turn to private data collectors for information. 

We find very little about the Fed outlook now that the debate is all about nominee Warsh. But the economy is booming, as we saw it the ISM manufacturing survey. The services will likely show the same robustness. Inflation remains well over the Fed’s 2% target no matter how you cut it. And the Fed's quarterly Senior Loan Officer Opinion Survey shows large and medium business loan demand in Q4 at the strongest since Q2 2022 and officers expecting even more. If we ignore the gloomier consumer sentiment surveys, the US economy is red-hot and getting hotter.

See the chart from Reuters.

The conventional wisdom (and the CME Fed funds betting) for two rate cuts this year flies in the face of the hot economy. But for some reason, nobody is talking about the need for a rate hike to cool it down. Presumably that’s because of Trump throwing a fit if the Fed were to hike. This strengthens the Warsh case for accelerating QT and selling off the Fed’s hoard of Treasuries, which in the near term reduces the money available at banks for lending and literally reduces the money supply.

A super-strong economy, even if not distributed evenly, implies a strong dollar. It would take some heavy-duty inflation readings to counter the high GDP, and according to some, we are not getting that tariff-induced scary high inflation, including Goldman Sachs. We never argue with Goldman.

We are seeing something similar in Australia, where the RBA wasn’t entirely sure it should hike rates, the first in the G10 and only six months after the last rate cut. But despite the consensus of a hike, it wasn’t built into the AUD and even after the decision, the AUD wobbled around for a while before taking off. And it still has not reached the highest high from before the rate hike. 

Forecast

We got the turnaround Tuesday yesterday, as always happens after a wild breakout. Since this particular breakout was not well-anchored—the US checking rates on behalf of Japan—it’s possible the turnaround goes all the way. That would take the euro back up over 1.2000.

But we suspect this is not likely and instead we may get a downside break of the 20-day (1.1761), the ATR breakout at 1.1681 and even the 200-day at 1.1617.  That would make the current move a dead cat bounce.

For this to happen—a resurgence in the dollar—the consensus sentiment has to shift to the hot economy and the sneaking suspicion the Fed is not cutting rates, after all.

This outlook is contrary to the general idea that “king dollar” is due for a comeuppance and “should” give back a big chunk of gains. But currencies are correlated over long periods of time with economic growth. Much as the world despises Trump, it is still buying US assets. Just as the stock market is not the economy, the president is not the country or its markets.

Assuming the dollar does resume its upswing, we need to worry about Trump will do about it. He wants a weak dollar. And starting a military conflict with Iran is exactly the opposite of what a weak-dollar preference would call for. Shooting wars tend to favor the dollar as a safe haven.

Tidbit: Here is a para from Bloomberg this morning:

Michael Burry, who rose to prominence for his wager against the US housing market ahead of the 2008 financial crisis, is warning that Bitcoin’s plunge could deepen into a self-reinforcing “death spiral.”

Burry argued in a Substack post that the original cryptocurrency, which has fallen 40% since peaking in October, has been exposed as a purely speculative asset, failing to take off as gold benefits from investor unease over US deficits and policymaking.

Further losses, he said, could rapidly strain the balance sheets of major holders, force selling across the crypto ecosystem and trigger widespread value destruction.

“Sickening scenarios have now come within reach,” Burry wrote.