Assumptions are dangerous things. The Fed is now making quite a few. In the fixed income world, the 10-year rose to a one-month high at 2.936% and settled at 2.901%, levels that don't pass the "So What?" test. So far today the 10-year is back down to 2.848%. If the bond market really believed the Fed's projections for next year, the yield should have sliced through 3% and stayed up there.
This is tantamount to the bond boys telling the Fed they don't believe the dot-plot forecast, probably because they do believe the flattish inflation forecast. Powell said "There is no sense in the data that we are on the cusp of an acceleration of inflation."
The Fed's forecast is for Fed funds at 2.1% by the end of this year, the same as at the December FOMC, rising to 2.9% by 2019 vs. 2.7% expected at the Dec FOMC. This is a tiny number! One ana-lyst noted that the change amounts to a 19 bp increase for end-2019, less than one standard 25 bp move. And it's based on the assumption that inflation simply has to appear by then. That will allow the Fed funds rate to rise to 3.4% by 2020 (from 3.1% at the Dec FOMC).
See the Bloomberg version of the dot-plot. It shows a rise in 2019 and 2020 that then drops off "longer-term." What does that drop-off mean? It probably means a lack of confidence at the Fed and by the Fed's backroom economists that growth and inflation will persist past the next three years and the Fed might have to pare back expectations and rates.
After all, we have no guarantee that inflation will magically appear in 2019 to justify the new forecast of three hikes that year, whatever the Phillips Curve may suggest. We could just as easily flat-line to the "longer-term." The black line shows the median consensus. Our pessimistic line is green. The gold line shows an alternative in which the economy stalls in mid-2019 and the Fed has to retreat.
We attribute altogether too much weight to the dot-plot. The Fed's economists are very, very good but they are not the only economists. A mid-year stall next year is just as likely as not, depending on how conditions develop, including retaliation in a trade war, China withdrawing reserves from the dollar, natural catastrophes, terrorism, wars, etc. We may not even need a catastrophic development. The econ-omy can just deflate on its own because of demographics, income inequality, losing the war on crime and drugs, and homegrown domestic terrorism. Offsetting these grim ideas are, of course, the effect of the tax cuts, hypothetical capital spending to boost productivity, actual real wage gains, and maybe some infrastructure spending.
We think the equity crowd will fall back on these Trumpian hopes while the fixed income crowd, the stubbornest bunch you ever met, will remain skeptical.
As a fun tidbit, Bloomberg reports that German manager Allianz thinks the dollar is a screaming buy because it's "cheap and just about every investor is short the currency." See the chart. Short dollar posi-tioning is the most bearish in four years and it's the worst performer among G10 currencies in the past year. We agree that positioning is a valuable indicator, but not the only one. There is nothing to say that just because something is down, it must go up. Think WorldCom and Enron. Granted, countries don't go bankrupt and out of business, and currencies can't go to zero, but there is no universal rule saying there is some limit to any move. We used to think there were limits on how stupid and incompetent a president could be, too.
A key reason to believe Allianz is wrong about the dollar is that Trump favors a weak dollar. He thinks it promotes exports and fails to recognize the countervailing capital flow story. Wharton must be hang-ing its head in shame. At 12:30 pm today, Trump is going to announce a major trade offensive against China, which will retaliate but probably softly, softly. The EU is beavering away behind the scenes with the US Trade Rep to get exemption from the steel and aluminum tariffs that go into effect tomor-row, alongside Canada, Mexico and Australia, with perhaps a few others.
The WSJ reports Trump is building a coalition to join the US in the trade war against China, paying for cooperation with the exemptions. This doesn't sound very Trumpian. He's a loner. And no coalition partner could or should trust him one inch. If a coalition is being formed, it's the work of others in the White House, possibly as a ruse to scare the Chinese. Good luck with that. Those guys make 50-year and 100-year plans. They can plan right over a nuisance like Trump. Besides, they know as well as the rest of us that nobody in his right mind would make a contract with Trump. He breaks them willy-nilly. All the same, whether the US actually implements tariffs and a trade war with China, the announce-ment effect could be a big dollar-negative. Or not, since it has been in the works for a long time and "should" be priced in by now.
As for the real economy we get the usual jobless claims this morning, as well as leading indicators, the Kansas City Fed, and the Markit flash manufacturing and services for March. These will all probably take a back seat to trade war and a Fed that is not really hawkish, after all. Nineteen points just doesn't cut the mustard. Net-net, we think the best bet is dollar short, but first we may have to wait for lousy data in the eurozone to fade.
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