Uncertainty from and about the Fed

Outlook:

The calendar today contains durables and consumer confidence, but of course the big news is tomorrow’s Fed statement. Most analysts look for no change in policy and little or no change in the wording of the statement. There is no press conference or revision to the Summary of Economic Projections, so everything hinges on the Statement.

One thing we can count on is that the Fed will make no promises or even hints about the December meeting—it is trying to wean us all from dates in favor of data (to which we say “Bah.”)

Uncertainty from and about the Fed will probably prolong the period of consolidation we are likely to be entering now. Nobody ever really knows whether a trend stops and go backwards—the consolidation--because traders are having seconds thoughts about the fundamentals, or because the chart shows a move went too far and too fast, or because traders have reached position limits and need to unload before resuming the primary trend.

Today’s chart favors the last two explanations. The euro nosedive was abrupt and big, pushing the euro deep into oversold territory. Consolidations often settle into a pullback that can be defined fairly neatly, complete with its own support and resistance channel and other characteristics of a mini-trend. We are not there yet with the euro. We can barely draw a standard error channel on the 240-minute chart. And yet experience tells us that the pullback is likely to hit the 25% retracement level of the recent move at 1.1115, or maybe the 50% level at 1.1242, which lies conveniently near the midpoint of the giant breakout bar. A confirming factor is the MACD in the bottom window, our most reliable indicator, showing a rise off the low that is likely to persist. The MACD is what will confirm a resumption of the downmove, assuming we get it. And beware! We don’t always get as resumption of a trend after a consolidation. Sometimes we get a reversal. It’s hard on the nerves.

Analysts often mistake a pullback as arising from fundamentals and then go out and torture the fresh data to make it fit. We might say the euro dipped today because of the bad lending data from the ECB…. or the failure of the euro to break the new consolidation channel to the downside is interpreted as a function of the German wholesale organization saying exports will reach a new record high next year. It may well be true that some traders acted on those news nuggets, but they are not telling us and to attribute fundamentals to what is a ruling technical-driven move is to guess. We do a lot of guessing but do try to avoid making guesses that can never be proved.

As for Big Picture fundamentals, some analysis is really interesting but again, we can point to some factors having driven a move only after the fact and then not with any real confidence. What motivates analysts and investors is not what motivates living, breathing day-to-day traders. The FT has a story today from a fund manager (Felix Martin at Liontrust Asset Management) who says the UK external account is five times GDP and badly out of balance, with long-term investments funded by short-term debt. The drop in foreign earnings, not trade, is what has sent the current account so far into deficit, now 6% of GDP (from under 2% in 2011) and the biggest deficit since records began in 1955. A surefire cure is to devalue the pound. He suggests traders could go gunning for sterling for this reason.

This is probable only if the current account deficit becomes a cause célèbre and the top Talking Point. It’s not out of the question, but on the whole, traders are not overly preoccupied by the current account. They would rather parse an unorthodox or contradictory comments from an MPC member, especially if it’s a disgruntled one. This is like the FX market ignoring the debt ceiling crisis in the US in favor of endless ramblings about the Fed and how bad all the indicators are (Fed funds futures, breakevens, etc.)—or endless talk about the jobs numbers.

This is not to say traders won’t start gunning for sterling. It’s a favorite indoor sport and can gather momentum surprisingly fast. But first we need traders are start talking about it. These FT op-ed pieces often fall into a bog and are never heard from again.

Somewhat similar in net effect are developments that we can interpret only long afterwards, like the Chinese Party meeting this week that will devise a new 5-year plan. It could be a big deal or it could be a dud, or it could seem to be a dud because the earth-moving aspects are not disclosed. We wrote last week that China issuing renminbi-denominated bonds in London is a big deal and possibly the savior of over-indebted and mismanaged state companies. We can hardly expect a secretive organization to let the cat out of the bag, can we? We can barely guess at the cat. And yet the FT boldly says the plan “has the potential to be one of the most momentous decision-making events in recent Chinese history.”

On the whole, stockbroker economics is good enough. By that we mean fast and shallow interpretation of news events in a knee-jerk, impulsive way. And to attribute FX moves to deep thinking and profound insights is almost always a mistake. Keep it simple.

When we can’t know what we don’t know, we have to fall back on the chart. If the Fed uses the word “normalization” tomorrow and/or makes specific note of global market conditions stabilizing, we will see the effect immediately on the chart. If it changes hardly any words, the absence will be noted, too. Only an outright promise of a Dec hike will likely reverse the current consolidative move.