US: Ideas about recession are fading away

Outlook:

Today the WSJ says investors are starting to accept the Fed will raise rates and they are not throwing a hissy fit. Ideas about recession are fading away as good data comes in and besides, the dollar is down 2.9% so far this year, relieving pressure on multinational com-panies. “Investors have readjusted their interest-rate expectations significantly in recent days. About a week ago, interest-rate futures priced in just a 4% chance that the Fed would raise rates in June, accord-ing to CME Group. But the odds rose to 26% by Friday. The yield on the two-year Treasury note, highly sensitive to the Fed’s policy outlook, rose by 0.13 percentage point last week to settle at 0.888%, the biggest weekly increase since November.” Separately, the FT reports that over half of 53 economists it surveyed now see the Fed hiking at one of the upcoming two meeting.

But we are not yet seeing the rate hike getting baked into the dollar cake. According to the FT, CFTC futures data for the week ended May 17 “showed hedge funds remained short the US dollar for the fourth consecutive week but trimmed short positions by $400m to $3.3bn.” Note that the CFTC report was released one day before the Fed minutes. This week’s report may show something quite different.
Something big has happened. Over the weekend, two Feds (San Francisco’s Williams and Boston’s Rosengren, said the economy is solid enough or near the threshold for a rate move. Rosengren is the more interesting because he seems to have switched from the dovish to the hawkish camp. This follows NY Fed Dudley last week.

The regional Fed supposedly do not consult Washington or one another in making public statements like this, but it sure seems like the WSJ’s use of the word “campaign” to change the market’s mindset is not misplaced. St. Louis Fed Pres Bullard, in Beijing today, said the slower growth rate is consistent with a “slowly rising path for the policy rate.” Bloomberg reports “The odds of the Fed raising rates in July have climbed to 48 percent from about 26 percent at the start of the month, according to data based on fed fund futures compiled by Bloomberg. The calculation assumes the effective fed funds rate will aver-age 0.625 percent after the central bank’s next increase.”

San Francisco Fed Pres Williams said the Nov presidential election will make no difference whatever to Fed deliberations—just data. The WSJ reports he is right. The Fed has made policy decisions in each of the 30 past election years except 1996. Williams said even Sept and Oct are not off the table. The Fed is resolutely apolitical. Well, he would have to say that, or rather, somebody from the Fed would have to say it. We don’t buy it for a minute. The possibility of a Trump presidency—and Trump firing Yellen in January—can’t be dismissed any more than some financial market turmoil in an im-portant foreign country be dismissed. For one thing, if it looks like Trump is winning by October, we could see the start of the resulting capital outflow and a falling dollar. Normally presidential elections don’t much affect the FX market, but this could easily be an exception. In fact, if the Fed expects out-flows, it might raise rates in both months.

We have never seen the Fed act like this before, but we have never had so risk-laden a presidential can-didate before, either. We give Fed pre-election intervention less than a 50% chance--but not zero. Simi-larly, the Fed meeting (June 14-15) comes just days before the Brexit referendum (June 23) but seems to have become a non-factor.

As we wrote last week, the Fed has no rise in inflation or inflation expectations on which to hang a rate hike hat. It is acting on a short run of better—but not outstandingly good—data that implies inflation should ensue. A lot of analysts are unhappy about implications and changing the world on a theory. To be fair, central banks always have to act on insufficient data and on theory—in this instance, that full employment simply must push up inflation eventually. And yet the die is cast, or so it seems. The Fed is out in force preparing the markets, all the markets, for a rate hike in June. It now remains for the bond gang to get on board. In the FX market, we need to beware a bout of extreme nerves. We also have to worry about “buy on the rumor, sell on the news.” In general, we need to start worrying.

Note to Readers: Next Monday, May 30, is a national holiday in the US (Memorial Day) and mar-kets will be closed. We will not publish any reports. Be prepared for Friday to be a very thin trading day, too.

		Current	Signal	Signal	Signal
Currency	Spot	Position	Strength	Date	Rate	Gain/Loss
USD/JPY	109.51	LONG USD	STRONG	05/08/16	107.91	1.48%
GBP/USD	1.4516	LONG GBP	WEAK	05/19/16	1.4629	-0.77%
EUR/USD	1.1209	SHORT EURO	STRONG	05/16/16	1.1309	0.88%
EUR/JPY	122.75	SHORT EURO	WEAK	05/02/16	122.33	-0.34%
EUR/GBP	0.7720	SHORT EURO	WEAK	05/02/16	0.7864	1.83%
USD/CHF	0.9906	LONG USD	STRONG	05/10/16	0.9738	1.73%
USD/CAD	1.3137	LONG USD	WEAK	05/10/16	1.2945	1.48%
NZD/USD	0.6788	SHORT NZD	WEAK	05/10/16	0.6749	-0.58%
AUD/USD	0.7222	SHORT AUD	WEAK	05/08/16	0.7354	1.79%
AUD/JPY	79.07	SHORT AUD	STRONG	04/02/16	81.17	2.59%
USD/MXN	18.3837	LONG USD	WEAK	05/06/16	17.9418	2.46%