Fed's window is closing fast because of the election on November

Outlook:

A WSJ reporter has a cute statement that you can’t tell if a central bank is out of ammunition if it’s not firing. BoJ chief Kuroda somewhat testily said that of course the central bank has plenty of tools—rates can go a whole lot more negative than -0.010%. As for the Fed, the statement writes of some improvements but also of softening household spending. Is this a down-grade of the US economy? Maybe.

The first paragraph alternates good data with bad data so you can’t get a grip on the net balance.
“Information received since the Federal Open Market Committee met in March indicates that labor market conditions have improved further even as growth in economic activity appears to have slowed. Growth in household spending has moderated, although households' real income has risen at a solid rate and consumer sentiment remains high. Since the beginning of the year, the housing sector has improved further but business fixed investment and net exports have been soft. A range of recent indicators, including strong job gains, points to additional strengthening of the labor market. Inflation has continued to run below the Committee's 2 percent longer-run objective, partly reflecting earlier declines in energy prices and falling prices of non-energy imports. Market-based measures of inflation compensation re-main low; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.”

No wonder the Fed removed the “balance of risks” sentence. It’s gone because members can’t agree on what it should say. Removing reference to global concerns may or may not be correctly identified as hawkish. The Fed still said “The Committee continues to closely monitor inflation indicators and global economic and financial developments.” This is a whisper of a hint of a suggestion that unless somebody blows up, the upcoming meetings will see the hike. As we wrote yesterday, the Fed’s window is closing fast because of the election on Nov 8. That pretty much removes the Sept and Nov meetings, leaving June or July, and then December.

The Fed disappointed. It seems to be relying on its one good leg, the drop in jobless claims and rising employment. But you can have good employment and a lousy economy. Japan has excellent job data, an unemployment rate of only 3.2%, plus a government that prods companies to raise wages. It’s not con-tributing to rising inflation.

Some analysts say the gigantic drop in the dollar/yen on the BoJ news means we should expect rising volatility across asset classes, and we agree. But let’s not get silly about it. The FT has an excellent arti-cle today on what is correlated and what is not. Nomura gets credit for running the numbers on 1961 inter-asset relationships seeking correlations for three months of 3-day changes.

“No surprise that one of the closest correlations, at 72 per cent, is between the USD/JPY and the Nikkei 225.” Here’s another one—correlation of the euro/Canadian dollar cross and the FTSE 100 is -77%. “This is because with the euro acting of late as a risk-off beneficiary and the Loonie a commod-ity currency, the EUR/CAD will often rise when the resources sector is dragging down the London-based equity benchmark.

“Perception of interest rate differentials is another powerful cause of correlation. The spread of two-year bond yields and the Aussie dollar/kiwi dollar cross sport a correlation of 75 per cent.” That’s all we get from this story but we look forward to more from the FT. Note that the strongest correlations are with equity markets—not oil or other commodities.

As for yields, we say the drop in the US 10-year indicates real-world traders remain skeptical about two hikes this year and we will soon be hearing forecasts of one at best and that one in December. The diver-gence between what traders say and what economists say continues to amaze. Fed funds futures continue to show a less than 50% probability of a hike while economists continue to believe it’s coming in June. Let’s assume the Fed always wants to prepare the market for a rate change, coddling the little darlings. The Fed could have said something along the lines of “the crummy first quarter is a seasonal aberration and we see a strong pick-up in the second quarter.”

We don’t see any such preparation or coddling going on in yesterday’s statement. Therefore we expect yields to continue to slide and the dollar to slide, too.

Longer run, we must expect an outflow of capital from the US if it looks like Trump might actually be-come the GOP candidate and even more so if it looks like he might win. We already have a threat from Saudi Arabia, and China and Japan can’t be far behind. Today German Foreign Minister Steinmeier took Trump to task for his speech yesterday asserting his policy would be "America first." For one thing, the US doesn’t run the world alone. Conflicts always involve several parties. "No American president can get round this change in the international security architecture." Besides, Trump is inconsistent, saying America First but also let’s withdraw from everywhere, which the NYT points out is Lindbergh 1930’s-style isolationism. Trump promised a “coherent” foreign policy but as many critics point out, he is not coherent, let alone well-informed, himself.