Beware of labor productivity and oil market before banking on a Fed hike

Outlook:

While we all celebrate another milestone on the road to normalization—the rate hike now almost certain on March 15—we need to keep a wary eye on a bunch of other things that are less happy.

One of them is the low capital investment in the US that has resulted in labor productivity at low and falling levels. It was former Fed chief Greenspan who homed in on productivity as the key metric for evaluating future growth. Back in the Bush Two years, we had a low-tax repatriation scheme that was supposed to raise employment. It didn't. It raised stock buybacks and executive compensation. Tax re-form now is similarly targeting already rich guys and corporate chieftains without specific incentives for capital investment. This is stupid, if par for the course.

To the extent that wage growth depends on productivity and you don't get sustained inflation without sustained real wage growth, normalization is at risk. It can stall. Talk of when the next hike is coming after March tends to jump to the end of the causation chain—inflation per se—rather than the contrib-uting factors like wage growth.

And then there is oil. No sooner did the EIA release a forecast for Brent averaging $55 this year and WTI about a dollar less, than the inventory reports pushed the WTI price below $50. The last time WTI was under $50 was Dec 15 when the low was $49.95. Market News notes that same day, 10-year US Treasury yields hit highs just under 2.64%.

What does this mean? Well, only that we have been here before. We need to be careful not to attribute a negative correlation between oil prices and the 10-year yield, which leads to the supposed negative correlation between the oil price and the dollar. Remember that the last time we had these two things happening at once was the day after the Fed decision day (Dec 14). Should we expect the same pull-back this time? Yes, probably. Some of it is profit-taking and some of it is second thoughts. Market prices overshoot. We should start gnawing fingernails only if the yield goes back under some critical level, like 2%, which we last saw in early November.

On the political front, Quartz reports that in France, LePen is luring women to the traditionally male extreme right by a laser-focus on how the rising threat of Muslims, migrants and globalization are bad for women while the Far Right favors women's rights interests. The story doesn't contain any recent poll data, just information on the big-picture shift from 2002 to 2012-2015. But consider that Trump won the US election in part on attracting more women than anyone expected, despite being obviously misogynist and personally repulsive, to boot. Overall, the majority of women voted against Trump, but he did win 53% of the white woman vote.

Also on the political front, Trump is playing a dangerous game and close to triggering a constitutional crisis by his obsession with Obama, levelling one false charge after another. FT columnist Luce says maybe Trump continues the obsession because Obama won the popular vote, twice, while Trump chooses to deny that he did not. On TV, talking head O'Donnell has a recurring theme—Trump is men-tally unstable and should be removed from office. Various newspapers carry the same story, citing big-shot university professors and shrinks. The NY Daily News has a story that psychologists are breaking the gag rule on talking about people they have not actually treated (a rule that came out from the Amer-ican Psychiatric Association when Goldwater was running). John Hopkins Medical School expert John Garner said Trump "is dangerously mentally ill and temperamentally incapable of being president." He has "malignant narcissism."

The question is whether a countdown may be beginning—how many batshit crazy comments can Trump make before McCain or other leaders start calling for him to step down? Allies must be wring-ing their hands, not to mention high Trump officials, who have to hustle to Nato to say "Trump doesn't mean it" or to China with the same message. If the American president is unstable, the whole world is unstable. A critical point could be a military mutiny—Trump calls for nuking N. Korea and the Penta-gon refuses. You can imagine all kinds of horror stories like this. But as a practical matter, we should not expect any such outcome. Trump is not actually stupid. Charging Obama with a felony was stupid, but on the whole, Trump knows where his self-interest lies. Getting booted out in disgrace is not in his self-interest.

And finally, if we all knew the ECB was going to leave rates and the buying plan in the same place, why did some traders buy euros (or reduce shorts)? The monetary policy divergence theme has been in play for years by now. Wishful thinking, maybe. Similarly, the Draghi press conference is not likely to deliver any whisper of a change in stance—and yet the euro can't seem to break 1.0500 to the downside and stay there. Yes, we have an overall downward sloping trend, but the trendline has been flat/horizontal since mid-November.

See the chart. What does this mean? We are not exactly sure but we don't like it. The euro has some solid support and the dollar has some heavy headwinds. If the chart shows a secret tendency to want to buy the euro, it would take only a faintest of whispers of tapering to change the trajectory. Food for thought—not a forecast. It's peculiar that a downside breakout does not look likely. Maybe it means the rate diff is already fully discounted.

                                            

Currency	Spot	Current Position	Signal Date	Signal Strength	Signal Rate	Gain/Loss
USD/JPY	114.83	LONG USD	03/02/17	STRONG	114.21	0.54%
GBP/USD	1.2149	SHORT GBP	03/02/17	STRONG	1.2278	1.05%
EUR/USD	1.0558	SHORT EURO	02/10/17	WEAK	1.0643	0.80%
EUR/JPY	121.13	SHORT EURO	02/03/17	WEAK	121.56	0.35%
EUR/GBP	0.8689	LONG EURO	03/02/17	WEAK	0.8575	1.33%
USD/CHF	1.0148	LONG USD	02/10/17	STRONG	1.0024	1.24%
USD/CAD	1.3516	LONG USD	02/22/17	STRONG	1.3174	2.60%
NZD/USD	0.6901	SHORT NZD	02/10/17	STRONG	0.7185	3.95%
AUD/USD	0.7501	SHORT AUD	03/06/17	WEAK	0.7594	1.22%
AUD/JPY	86.06	LONG AUD	02/09/17	WEAK	85.92	0.16%
USD/MXN	19.7295	SHORT USD	01/31/17	WEAK	20.8108	5.20%