Fed doesn't much care about the dollar

Outlook:

We get Aug PPI today and CPI tomorrow, but these are not numbers the Fed is look-ing at—it prefers the PCE deflator, and besides, jobs and the quality of jobs, plus wage increas-es, are the Fed’s focus as it begins the meeting today. The other big item on the Fed’s agenda is managing market expectations. Market expectations are all over the lot, with a very big cohort in the undecided camp. It will take a change in the “considerable period” wording to get a decisive move one way or the other. We say that if the Fed retains the “considerable period” language without any change at all, the 10-year yield will slump to some horrible low number (like 2.30%) and the dollar will tank. Is the Fed so insensitive to the market that it doesn’t know this will be the outcome? No, the Fed knows. But the Fed doesn’t much care about the dollar, either.

As noted above, the market is massively short the euro, so a disappointing Fed statement tomorrow could drive a short-covering frenzy. In fact, this is what we expect. But before running out and betting the ranch on an upside euro breakout, remember that the Big Picture remains the same—divergence be-tween the two economies and the interest rate trajectories. We haven’t even heard details of ABS in Eu-rope and we don’t get the outcome of the TLTRO allotments until later Thursday morning. These could be feeble and restore the downtrend. For the fate of the euro/dollar to ride on Fed statement vs. TLTRO is a dumb way to run a market. It’s temporary and it’s noise.

Meanwhile, the 2-year continues to rise. It’s quoted this morning at 0.54%, up 13 points in the last month (Bloomberg). Analysts say it’s the 2-year we should look at when a tipping point is looming, not the 10-year. The German 2-year is quoted at -0.08%, down 6 points. Two things: traders at the short end are heeding the San Francisco Fed’s research that deduced the market was underestimating the Fed’s pace. Secondly, the US-German differential is widening. This is the basis for a lasting belief in the dollar’s rise against the euro.

The biggest event this week is arguably the Scottish referendum. The FT has a front-page photo of a gimlet-eyed Greenspan and a story that he, among other bigshots, thinks Scottish independence is a mis-take. The UK is the US biggest and best ally. The White House spokesman said “We have an interest in seeing the UK remain strong, robust and united.” Greenspan points to the declining North Sea reserves and comments that the Nationalist party is irresponsibly underplaying the negative consequences of in-dependence. “Their [oil] forecasts are so implausible they really should be dismissed out of hand.” And Greenspan says “There’s no conceivable, credible way the Bank of England is going to sit there as a lender of last resort to a new Scotland.” The UK will not agree to a currency union, and if Scotland tries to use the pound, its differing fiscal policies would cause a quick break-up.

The FT story goes on, Scotland is where the nukes are. The Scots don’t want them—by a vast majori-ty—but the US and UK do want them there. Besides, the UK doesn’t have a good place to put them. Gee, isn’t that a bargaining chip?

We are quite offended on behalf of the Scots that they are being pressured so hard to stay where they don’t want to be. The US, in particular, should be more in tune with a vote for independence. The origi-nal states didn’t have much of a chance, either… and let’s not forget that many of the principles upon which the US was founded came from Scotland in the first place. Having complacently not prepared for a breakup for the union, the English are now scrambling for battle and bringing out all the knives. It’s shockingly bad behavior, as usual in politics, and it may succeed in scaring off the independence vote. The problem is that a sterling rally in the event of a No vote—the most likely outcome but not coming until overnight Thursday/Friday—will probably be short-lived as attention turns back to the real econo-my. Trading sterling for the next week is a losing proposition.