This week has so much data, our heads will be spinning. If you need a good calendar, by the way, Econoday.com offers a pretty good one (free). Tomorrow we get July retail sales, possibly a biggie after June disappointed. Wednesday it’s PPI and Thursday, CPI. Friday it’s housing numbers, including the NAHB index and housing starts and building permits.
Wall Street guru Lynne says we need to watch the equity markets. “Thursday could be the day that seals the market’s fate for the next few weeks, because it’s the 15th, and 45 days before the quarter ends, often the time frame by which many hedge funds require redemption requests to be submitted. Granted, some hedge funds have kept pace or exceeded the returns a passive index fund would have enjoyed this year but even those are vulnerable. Smart investors surely want to book some profits now, rather than risk riding their gains down, in the next sell off. There haven’t been as many nervous longs since the first post-financial crisis rally that started in March 2009.”
In the bond market, meanwhile, the only real thing on the agenda is the July FOMC minutes next week (Aug 21). Market News reports the fixed income crowd is starting to gear up for the August jobs report (after Labor Day) and then the next FOMC on Sept 17-18. Opinion is sharply divided on tapering. The majority see the announcement at the Sept meeting, as we have been trained to expect, but at least one big house (BoA Merrill Lynch) sees December. And before then, “With this week's $72 billion Treasury refunding out of the week, several analysts are calling for the Treasury market to stage a rally.” The 10-year could dip to 2.45% (RBS), or even 2.40% (Nomura).
Here are some of the reasons for a rally in Treasuries (and a drop in yields that presumably harms the dollar): we sometimes get a seasonal “micro-rally” in August; reinvestment flows; a dearth of corporate bond issuance in August, a drop in August appetite for equities; perception that the equity crowd is “not as prepared as bonds for a potential QE3 tapering by the Fed, and a general sense that Aug and Sept are when we get Shocks (including Lehman in 2008 and the US sovereign ratings downgrade in 2011).
Finally, if the bond market has indeed priced in the tapering for Sept at $20 billion, the actual announcement could have the opposite effect and seem dovish! In fact, if tapering is premature, economic data could start coming in really weak (including deflation) and lead to yields at 1.50%...
Of all these comments, the one we find the most troubling is from Lynne and confirmed by the fixed income view of the equities crowd—they don’t believe tapering is real, they are not prepared, and they will freak out when it really does get announced. A giant rout in equities shouldn’t influence the Fed, but they are not entirely ivory tower. They have to notice. So, if we are seeing comments like this, the Fed must be seeing comments like this, too, and perhaps remarks by various Feds speaking this week (including Bullard) may be directed toward convincing the die-hards. The WSJ notes that FX traders are backing away from the one-note-Johnny approach, that tapering means higher yields and higher yields means a stronger dollar. The paper says that CFTC data show traders have “cut bets on a rising dollar by 49%, to $21.7 billion, since late May. Then, the value of wagers hit its highest level since at least 2007, when the U.S. Commodity Futures Trading Commission first started to track the data.”
The WSJ needs to sell newspapers so it quotes a guy who thinks the strong dollar thesis doesn’t hold up and besides, the economy doesn’t support tapering in Sept. December, maybe. Well, this is a guy talking his position. For one thing, it completely ignores that tapering is not the only factor—data from other places has been tremendously important over the past few weeks. Yes, emerging markets took a hit but in some cases, they deserved it for reasons unrelated to tapering (India). Besides, Bernanke doesn’t want to wait until ten minutes before he leaves the Fed. Still, talk is rife of a delay, and it’s possible that strong data elsewhere and weak data in the US could prolong the process. The dollar is not a slam-dunk. Well, gee, it hardly ever is and certainly was not this time, either.
Watch yields. If we start getting those levels around 2.40%, we will start worrying—but not before.
This morning FX briefing is an information service, not a trading system. All trade recommendations are included in the afternoon report.