This is a big data week, with the Fed Minutes tomorrow

Outlook

As noted above, Friday’s inflation report was not okay. Core services prices rose 4.8%. The earlier jobs report was not okay, either, and looked okay only because of seasonal adjustments. The Fed is smart enough to know these things and the dead-cert rate cut, whether June or July, is looking less dead-cert by the day.

Weirdly, if the stock market persists in punishing big tech, we could be in for a big retracement. The Fed is not supposed to care about equity markets, but realistically, it may. Somewhat oddly, the BoA/ML managers survey shows investment managers still highly bullish.

This is a big data week, with the Fed minutes tomorrow, along with UK CPI and US durables. Thursday brings the US trade balance and the start of the PMI flash readings. Today Canada reports inflation but we guess the Carney stance is more important.

The Munich Security Conference had some surprising outcomes, including several European leaders boldly saying they could go it alone without the US if they really tried and SecyState Rubio trying to walk back Trump insults (but not succeeding). From the FX point of view, the critical idea was the EU thinking about making the effort to take a bigger slice of the currency world. They know perfectly well that getting wider euro usage in trade and reserves means revaluation. As we know in the US, being the numeraire and reserve currency comes at a high cost.

Reuters’ Dolan has a good essay on the prospects. Starting with the Greenland debacle, Europeans have “renewed impetus to deepen European capital markets integration. Leaders also discussed possibly expanding joint euro debt sales and - led by the European Central Bank on Saturday - widening euro access, liquidity and financing worldwide. Some of this has been on the table before. But the urgency for action is now evident in a willingness for a two-speed advance with six core countries - Germany, France, Italy, Spain, the Netherlands and Poland - in the vanguard if agreement among the 27 is too cumbersome or slow. An EU6 summit is due early next month.

“The plans are likely necessary, even if not yet sufficient, to expand the role of the euro and allow it to absorb some of the nervousness about the world's overexposure to dollars at a time of enormous U.S. political and economic upheaval. Whether that greater global role brings a less welcome appreciation of the euro's value is another question.”

This could be an overriding theme for the full year and beyond. Let’s make one point upfront: the US has “extraordinary privilege” in the form of being allowed to have lower government issue yields because it’s the most used and most reserved currency. Sharing that top spot with Europe will remove some privilege and cause US yields to rise to continue to get the capital inflow. This is not something Trump appreciates but Bessent should

Off on the side is another factor—China has been seeking the same thing for some time now, and making some progress, mostly in promoting the yuan for trade transactions. In a competition between the EU and China to unseat the US as the top currency, we’d bet on Europe, despite its many MANY shortcomings and China’s far superior planning and bureaucracy. That’s because China is communist and does not give legal protection to private property rights. This is a very big deal. 

See the Reuters chart. This is partly a push you/pull me outcome. Traders and investor are hedging dollars more than they are outright selling, but actual selling could be in the cards. As long as Trump is in the White House, that push will remain. AS for the EU having the chops and administrative capability to unite well enough to pull off the euro’s bigger role, that remains to be seen. We must not forget these guys have been at war with one another for over a thousand years and the EU is still pretty young and the euro was launched only in 1999.

Japan

PM Takaichi and BoJ Gov Ueda had their first meeting. Oh, to be a fly on that wall. Unhappily, Q4 growth was a mere 0.1% instead of 0.4% forecast.

Forecast

It’s hard to understand how the 10-year yield can drop to only a whisker over 4% and yet the dollar continues to gain. This is not how things are supposed to correlate. We worry about a turnaround Tuesday. We also worry about the market mis-interpreting the US data—what if traders start acknowledging it’s not as favorable to a cut as thought? That bring up the Fed vs. Trump all over again. We can’t see a dollar drop coming, at least not yet, but it must be in the cards just waiting for a trigger.

Food for thought: We keep showing the chart of how much the dollar has risen over the past decade with the assumption it “should” drop back. Embedded in the idea of a necessary dollar devaluation is the really bad Trump mismanagement of the US government, offset by a so-far okay economy, albeit one with widening cracks. The dollar has fallen by 12% since Trump took office.

All the same, the real exchange rate (adjusted for inflation) remains 13% above it’s average for the past 30 years—as the chart shows.

The Economist magazine’s Big Mac Index (Jan 31 issue) has the dollar overvalued against 49 of the 70 countries surveyed. The dollar is overvalued by a large amount for Europe by 6.08% and Switzerland (9.08%, but vastly undervalued for China (3.66%), Japan (3.33%) and India (2.51%). (A Big Mac in India is chicken…).

It has a way to go. Something economists tend not to consider is what happens if and when Trump loses muscle. That could happen in the November midterm elections, especially if the Dems take the Senate. Even taking just the House would be a blow. We suspect a Dem win would remove some pressure on the dollar. It could also reduce interest in gold.