The calendar is fairly skinny this week, leaving everyone plenty of time to judge the Fed, especially with Powell testifying again and plenty of regional Feds now free to speak out again, having had to keep silent ahead of the policy meeting last week.

We will not likely get an explanation for how the Fed can be “hawkish” while at the same time the 10-year yield is sinking, the 30-year is under 2% for first time since February, and the 5-year/30-year spread is the smallest since December, as Bloomberg notes.

The Bloomberg editorial opines that the Fed is changing its mind about the priority of employment over inflation and possibly turning back to putting inflation first. Powell is “clearly more concerned about an inflation overshoot than an employment undershoot. This is a change after months and months of being more concerned about weak labor markets.”

It would represent a discard of the “let’s overshoot inflation” stance announced at Jackson Hole last year. “Either way, the point is not just the 2023 dots, but the broader trajectory of the Fed itself. For awhile it felt like the message coming from the Fed was "full employment above all else" but after a few hot inflation readings, some of the old thinking about the risk of temporary inflation turning to undesirable higher inflation via the expectations channel is back. That feels more like the Fed we've come to know all these years. The Fed that raised rates multiple times in 2018.”

So, is the Fed changing its mind? No. For one thing, re-prioritizing back to “inflation first” would make the Fed appear wimpy and damage its credibility. For another, even though we keep trying to discard the Phillips Rule that postulates a tight correlation between employment/wages and inflation, we have now had several lousy job reports in a row. We can study Covid-influenced flexible price rises vs. inflexibles and point to specific issues like those used car prices, but in the end, you don’t get lasting, significant, sustained inflation with 15 million still unemployed. The Fed’s forecast of inflation being transitory has been backed up by economists doing their own studies, including the Big bank economists who get the headlines, and they in turn influence the bond boys.

Powell is a classy guy and will not tap-dance around inflation vs. jobs, as Greenspan (say) would have done, deliberately confusing everyone. His testimony to the House is about the Fed’s response to the pandemic, a broader topic than inflation vs. jobs. This may give him a chance to position back to jobs as the best measure of recovery.

One problem he can’t resolve is the conflict between forecasts and data. The Fed has always been a bit weaselly on this topic. Most recently it insists it will act on data and NOT on forecasts, but then it wants the world to accept its forecast of inflation being transitory. Powell says the dot-plots of accelerated tapering are “only” forecasts, not data. Not exactly hypocritical but not exactly clear, either.

A final reason for Powell and Co. to return to the priority of jobs is that any more hawkishness might well freak out the stock market. The Fed would really prefer not to have anything to do with stock markets, least of all take blame for influencing them downward. The Fed pretends it never actually looks at the indices and is above all that chatter, but let’s be realistic–of course it knows the stock market hangs on its every word. It would prefer to be taken out of the stock market equation without having to say out loud that it’s a silly marketplace full of nitwits who buy into their own greedy narratives and can’t take a dose of reality.

As the FT reports on the European exchanges dropping on the Bullard comments last Friday, “’This looks like a market that got too invested in the prior Fed story, which it may have taken far too literally,’ said Robert Carnell, head of Asia-Pacific research at ING. ‘Central banks don’t seem to be able to control the reality shock that hits markets when a more reasonable version of future events is revealed to them,’ he added.” To which we say “Bravo.”

Assuming that means the reflation trade is coming back, it can come back stronger than before, implying the dollar retains its momentum. The only fly in this ointment is the yen, where the gain seems to imply a risk-off mentality at odds with the rest of the market. Maybe Japanese and other yen investment managers made a mistake. Maybe it has something to do with the Olympics. Maybe they know something we don’t.

Bottom line, the narrative remains a robust and resilient US economy that supports inward investment and other preferences for holding dollars. It would be helpful to the dollar if the vaccination programs would get a boost. Missing the July 4 deadline for a 70% vaccination rate could be a downer.

Tidbit: It’s Prime Day at amazon.com, with “bargains” galore to tickle the greedy materialistic consumer. It’s actually fairly disgusting but also the basis of the UN forecast that the US will be the top destination for foreign investors this year and next. In addition, the Fed releases the bank stress test results this week and they will likely release the banks from the rule against paying dividends higher than one-year earnings and engaging in buy-backs.

This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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This morning FX briefing is an information service, not a trading system. All trade recommendations are included in the afternoon report.

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