Bond markets fear that the Fed might be bluffing

Outlook:

The US calendar is pretty full today—chain store sales, initial jobless claims, the Challenger job-cuts report, labor productivity and costs, factory orders—and the money supply and the Fed balance sheet. Finally, after the close today we will get the US bank stress test re-sults. It’s not clear that anyone outside the sector cares very much, except maybe Mr. Buffett, who com-plains that nobody can read the banks’ financial statements and bankers are obviously in denial about the natural limits of profitability in what should be a low-margin business.

There are still only two Big Stories, the ECB plan for QE and US payrolls.

We will get Mr. Draghi’s choreography later this morning on QE—who, what, where and when. Will the ECB’s bond buying start right away or be delayed? Will it really be €60 billion each month? We also get revised forecasts, which contribute to the “why.” The exact details about QE have the potential to affect the euro today. Normally we expect the opposite of the logical outcome because traders al-ready sold on the rumor. Now they should buy on the news.

But maybe not. We didn’t get that affect in the dollar. Each of the three QE announcements were dollar-negative from the get-go. There is even more uncertainty in Europe about QE than there was in the US, and there was plenty of uncertainty at the Fed at the time, as newly released transcripts show. For one thing, US rates were not negative when QE was introduced and never did go negative in the relevant maturities. Most people are having a hard time wrapping theirs minds around negative yields. Another problem is context. How can Italy be yielding 1.40% when Germany is yielding 0.37% and the US, 2.13%.

One important difference between the Fed and the ECB is that the Fed doesn’t give a flying fig about the dollar, but the ECB views the level of the euro as symbolizing confidence in the ECB as an institution. This is not to say we expect outright intervention if the euro keeps falling to parity, but we would cer-tainly expect some rumbles and maybe a change in the dance-steps. We fear Draghi will not disclose as much of the operational information as traders feel they need to hear.

After trying to digest whatever the ECB is going to come up with—and it’s an hour later this time be-cause the meeting is being held in Cyprus—it’s on to US payrolls. Yesterday ADP predicted the private sector component will be 212,000 in Feb, against the latest consensus of 240,000 for both private and public sectors. This is a level consistent with removing “patient” at the March 17-18 FOMC. Some ana-lysts are impressed that ADP raised the Jan estimate from 213,000 to 250,000. If we get a revision like that, the Feb number is worth less, so to speak. But the bond market is not convinced just yet. Market News notes that the 10-year yield high during Feb was 2.14-2.16% and we are not back there yet so far in March. If bond guys trade in advance of the news, the yield “should” be higher—right?

The problem is the bond market fears the Fed is bluffing. But rising expectations of inflation could do the trick to convince them otherwise. According to the FT, 5-year inflation expectation rose to the high-est since Sept, to 1.7% yesterday from 1.04% earlier this year. Actual inflation is still well under the 2% target, casting doubt on whether Yellen can reach “reasonable confidence” that inflation is well and truly on the way, a rise in expectations not being the same thing as actual inflation. Here’s the kicker: data is getting increasingly hard to interpret. And “Fed officials are determined not to repeat the experience of the mid-2000s, when the central bank got behind the curve with rate rises and lifted them 17 consecutive times between 2004 and 2006. This supports the argument for the Fed to pull the trigger relatively early and to go on to raise rates cautiously and less methodically as it weighs the impact of the first increases since 2006 on the economy.”

Really? Maybe instead it means a cowardly approach to the First Hike.

As we noted yesterday, going into payrolls is when retail traders need to get out of the market. Prices will gap over your stops and targets. From the point of view of the professionals, you are the gladiator and they are the lions. We expect the usual spikes tomorrow and could get spikiness today, too. We can imagine a scenario in which the euro rebounds strongly or continues south in a straight line. If old hands don’t have a decent forecast, now is the time to retreat and just stay tuned.