The US is no longer on a tightening path, sell dollars

Outlook:

We get a lot of speeches by central bankers today and we shall see if it’s noise or useful. Atlanta Fed Bostic speaks early, then Chicago Fed Evans and Boston Fed Rosengren—all before noon. We also get the Bank of Canada rate decision and policy statement this morning. This one is actually pretty interesting—will Poloz pull in his horns like the Fed, or bravely follow the “natural rate” model? And BoE gov Carney suffers a Q&A this morning, too.

Then this afternoon at the usual 2 pm hour, we get the minutes of the Dec 18-19 FOMC. Powell’s retreat came after this meeting so it might be fun to see whether the Board saw inverting yield curves and crashing equity indices as contaminating the economy and creating a self-fulfilling recession. This was the stance yesterday of St. Louis Fed Bullard. The WSJ reports he is upbeat about the economy, but “fears it could be pushed into a recession if the central bank presses forward with more rate increases. ‘We’ve got a good level of the policy rate today’ and there isn’t any pressing need to go higher.”

Talk about Fed capitulation to political pressure has vanished in a puff of smoke. This is odd and unusual. The stock and bond markets got what they wanted—an end to rate hikes—and never mind that this is what they always want. Criticism of the Fed for always being “behind the curve” or “fighting the last war” are nowhere to be found. For once, markets think the porridge is not too hot and not too cold, but just right. This hardly ever happens! It’s hard to know whether it came about because the Fed feared a self-fulfilling recession just this one time—after all, we had inverting yield curves at various times for over a year—or perhaps there is a new appreciation for market feedback at the Fed under Powell’s leadership. Powell is considered a sharp cookie with good business instincts.

It would be nice to imagine that the feedback story is the right one. After all, the Fed is not the enemy, despite talk about punchbowls. A tone-deaf Fed has been a problem in the past, especially under the sainted Greenspan, who made plenty of mistakes. The biggest was the “great bond massacre” of 1994, when a flat economy suddenly led to the biggest loss in bond market history. Firms went under (including no fewer than three of our RTS clients). At the start of the year, according to Fortune, it was the 34th month of economic expansion, bond yields were historically low and inflation seemed negligible: Wages were going nowhere, and companies dared not raise prices.”  The Fed raised rates by 75 bp by May and bond rates jumped 1.5%. The mortgage market collapsed. In the end, the 30-year started at 6.2% and ended at 7.75% by mid-September, causing losses of at least $600 million. This was the time when over-leveraging by greedy hedge funds got blamed and “hedge fund” became a dirty word.

We may think events in 1994 (or earlier, as in the 1989 unexpected drop in Fed rates) are irrelevant today. Think again. Those who do not learn from history, etc.

We wonder if the Fed listening harder to the market and responding at least rhetorically, if not with outright action, is not a better way to manage. The Fed has spent millions refining its transparency and communications. Fed watcher literally count words and tease apart infinitesimal semantic nuances. This is silly. The worst thing ever said in public life (until Trump) was Greenspan’s remark that “if you understood me, I must have misspoken.” For shame! 

And let’s not forget that Powell did not say no hikes this year. We can easily get a hike in Q2. We continue to think the Fed must hike at least once to avoid the appearance of having been bullied politically. But Powell perceived the market was freaking out and needed to be calmed down, and he did the right thing.

In Europe, Mr. Draghi has been very forthcoming on the surface. Everyone loves his press conferences and expert grasp of concept and data. But he’s as slippery as any central bank governor, if not more so. If we are entering a new age of frank and open back-and-forth between central banks and big market players, will he follow?  We might even have to worry about charges of oligarchy and the capitalist elite in cahoots (think France).

What does a suddenly friendly and responsive Fed mean to the FX market? So far traders can’t see beyond their noses. The US is no longer on a tightening path, sell dollars. Well, the ECB is not likely on a tightening path, either. We are told to expect the ECB tapering to lead to the first hike in the fall. Because of various factors, including a slowdown worse than we thought (despite whistling past the graveyard), it won’t be long before expectations become more realistic. This should be dollar-supportive.

In the meanwhile, Trump thinks the stock market reflects his performance (and never mind petty little things like earnings). Accordingly, he is now motivated to get a trade deal with China. This takes away the risk-aversion reason to stay dollars. And the interest rate reason has been taken away, at least for a quarter or two. You’d think this would be wildly dollar-negative. But we worry… so much can go wrong.  Yesterday we got the usual Tuesday pullback. But it may be short-lived.

Political Tidbit: Trump used eminent domain to claim prime time from network TV last evening to launch his re-election campaign, sending emails before and after to supporters asking for donations to a fictitious “border security fund” (but disclosing in the fine print the money is really for his reelection campaign). Sleazy. He claimed a humanitarian and national security crisis at the southern border, lying about the data and blaming the Dems for the shut-down despite having said he is “proud” to own it.

TV commentators pointed out (repeatedly) that there is no crisis at any border and illegals and drugs come through the points of entry, not over at unguarded or unwalled locations. And also that immigrants perform fewer crimes of all types, from murder to breaking the speed limit, than native-born Americans, so there was a racist tinge to Trump’s speech. He tried a little phony heartstring pulling, claiming to have looked in the eyes of anguished murder victim parents. We would bet a large amount he has never met a single one. And what does a humanitarian crisis mostly of his own making have to do with shutting down the government?

The Dems in their rebuttal said temper tantrums are bad governance--let’s open the government and talk about border security separately. Nothing new was said and nothing was achieved. Why did Trump do it? To distract attention from the Dems just taking the House--and recover the spotlight. To distract attention from special prosecutor Mueller closing in on Don Jr. To raise money for 2020.

The TV networks will think twice about giving Trump free campaign time the next time. We would have preferred NCIS to this phony. It’s not even good showmanship.

Observers expect the Dems in the House to offer bill after bill—based on a Republican Senate bill—to re-open the government. The only interesting thing about it is that Republicans are starting to defect, with one more Senator to go to get it passed. If Trump refuses to sign to re-open the government, it’s unanimous that more will defect. Breaking Trump’s stranglehold on the Plubs is a good thing. So far they have been fearful of being “primaried,” meaning if they speak out against Trump, he will find an ally to run against the maverick in a party primary. Now because of the shutdown and Trump’s general sleaziness, being associated with Trump at the next election is worse.

Trump’s constant lying is not helping, either. Amid all the fact-checking, we found this little gem—immigrants from Canada and Europe falling off dramatically over the past three decades. This says nothing favorable about the quality of life in America vs. Canada and Europe.

 

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