Two rate hikes since last year have weakened the dollar. Why is that, and what’s ahead for dollar, currencies & gold? And while we are at it, we’ll chime in on what may be in store for the stock market…
The chart above shows the S&P 500, the price of gold and the U.S. dollar index since the beginning of 2016. The year 2016 started with a rout in the equity markets which was soon forgotten, allowing the multi-year bull market to continue. After last November’s election we have had the onset of what some refer to as the Trump rally. Volatility in the stock market has come down to what may be historic lows. Of late, many trading days appear to start on a down note, although late day rallies (possibly due to retail money flowing into index funds) are quite common.
Where do stocks go from here? Of late, we have heard outspoken money manager Jeff Gundlach suggests that bear markets only happen if the economy turns down; and that his indicators suggest that there’s no recession in sight. We agree that bear markets are more commonly associated with recessions, but with due respect to Mr. Gundlach, the October 1987 crash is a notable exception. The 1987 crash was an environment that suffered mostly from valuations that had gotten too high; an environment where nothing could possibly go wrong: the concept of “portfolio insurance” was en vogue at the time. Without going into detail of how portfolio insurance worked, let it be said that it relied on market liquidity. The market took a serious nosedive when the linkage between the S&P futures markets and their underlying stocks broke down.
Bringing forward expectations of a Fed hike from May-June to March was worth something for the dollar, but to get more now, the market may need to recognize the risk of three (or more) hikes this year. With the strong February jobs growth and a 2.8% year-over-year increase in hourly earnings, rarely does the market’s confidence in an event surpass current expectations for a hike on March 15.
However, the market sees around a one-in-three or a one-in-four chance of a third hike this year.The risks for the updated forecasts from the Federal Reserve seem asymmetrically tilted higher, more rate hikes than fewer by more members. The hawkishness of regional presidents may be underestimated. The data and the global climate are conducive for expediting the normalization process. The hawks will likely feel vindicated by recent developments and may press their case with more vigor.
The focus of the Fed has arguably shifted. Previously, the issue was whether the data would confirm that the economy was evolving toward the Fed’s targets. It did. Rather than focus on the data points per se, officials appear more confident of the direction and resilience of the economy and prices. They now are looking for opportunities, which helps explain the campaign to prepare the market for the March 15 move.
Still, the dollar’s technical tone has deteriorated, and the risk is on the downside over the next several sessions. Our working hypothesis is that the dollar’s recovery that began in early February against most of the majors ended and a correction has begun, For the Dollar Index, this means potential toward 100.75 and possibly 100.40. The former is the 50% retracement of that rally and coincides with the 100-day average (~100.80). The latter is the 61.8% retracement. Alternatively, if the Dollar Index has carved out a double top near 102.25, the neckline is around 101.20 (38.2% of the rally is ~101.10). On a break of the neckline, the measuring objective is 100.
The euro’s pre-weekend rally saw it surpass the 50% retracement objective of its decline from the February 2 high near $1.0830. That retracement was around $1.0660, and the 61.8% retracement is closer to $1.0700. The euro’s five-day moving average crossed above the 20-day average for the first time in a month. The single currency may be tracing out a double bottom at $1.05 The neckline is $1.0630. The measuring objective is around $1.0760.
The Eurozone economy is out of the deflationary-crisis mode. Draghi drove down government borrowing costs and the economy is beginning to turn the corner. In addition, yesterday he signaled that policy is shifting towards neutral.
Here is another theory:
Eurozone political risks are as high as ever. There is an election on Wednesday on the Netherlands that will almost certainly end in gridlock. That will be followed by a vote in France at the end of April where one of the leading candidates wants to quit the euro.
On top of that, sight deposit data shows recent SNB intervention. FX holdings at the central bank were up 3.8% in February, the biggest rise since December 2014.
A third theory:
The SNB is preparing to do more, in the form of cutting rates deeper and the insiders are getting their money out of franc.
The market is laser-focused on the Fed decision on March 15, but about 14 hours later, the SNB decision could steal the show
A Korean special prosecutor indicted Samsung chief Jay Y. Lee on bribery charges.
Korean press is reporting that China has told its travel agents to halt sales of holiday packages to South Korea.
Bulgaria’s interim government said it may apply to join the eurozone within a month.
South Africa’s main labor union Cosatu accepted a government-proposed minimum wage.
New Commerce Secretary Ross appears to be taking a less confrontational stance with regards to Nafta.
Press reports suggest Mexico may request a swap line from the Fed.
Peru’s central bank cut reserve requirements again.
In the EM equity space as measured by MSCI, Turkey (+1.5%), Czech Republic (+1.4%), and Mexico (+1.2%) have outperformed this week, while Colombia (-3.4%), Brazil (-2.1%), and UAE (-2.1%) have underperformed. To put this in better context, MSCI EM fell -1.4% this week while MSCI DM rose 0.3%.
In the EM local currency bond space, India (10-year yield -11 bp), Poland (-9 bp), and Indonesia (-3 bp) have outperformed this week, while Turkey (10-year yield +44 bp), Colombia (+18 bp), and Malaysia (+14 bp) have underperformed. To put this in better context, the 10-year UST yield rose 18bp to 2.50%.
In the EM FX space, MXN (+1.6% vs. USD), PLN (+0.4% vs. EUR), and ARS (+0.2% vs. USD) have outperformed this week, while COP (-3.1% vs. USD), TRY (-3.0% vs. USD), and KRW (-2.2% vs. USD) have underperformed.
A Korean special prosecutor indicted Samsung chief Jay Y. Lee on bribery charges. He is accused of exchanging bribes for government favors, which were uncovered during the investigation of President Park. Lee allegedly directed tens of millions of dollars to a confidante of President Park in return for government support of a 2015 merger that benefited his interests. These developments could fundamentally change the role of the chaebol in the Korean economy.
Korean press is reporting that China has told its travel agents to halt sales of holiday packages to South Korea. If confirmed, the move would likely be in retaliation for Korea agreeing to deploy a US missile defense system. Spokesman for China’s Foreign Ministry said he wasn’t aware of any such measures while an official at the Korea Tourism Organization (KTO) said China has issued the ban. KTO estimates that nearly half of the foreign visitors to Korea last year were from China.
While virtually all prominent market commentators, most recently Bloomberg’s Mark Cudmore, now seem convinced that the Fed will hike by 25bps on March 15, when just as recently as a week ago the question was June or September, some are still skeptical. One among them is Vincent Cignarella, FX strategist who writes for Bloomberg, who in his daily Marco View piece writes that “March is far from a slam dunk even if officials collectively see three hikes this”, and that the key clue will come tomorrow at 1pm when Janet Yellen speaks, and very well may stun markets who have sent the probability of a March hike up to 90% following recent hawkish comments from uber-doves Dudley and Brainard.
Here is Cignarella explaining why “You Should Be Nervous About Janet Yellen’s Speech”
Foreign-exchange and Treasuries traders may have gotten ahead of themselves.
While it seems obvious based on recent economic data that the Federal Reserve will eventually need to raise rates, Chair Janet Yellen could walk back market expectations on Friday to create padding for risk events ahead of the March 15 decision.
If so, markets appear precariously perched. Dollar-yen has risen around 2.5 percent and the U.S. 10-year yield has climbed more than 16 basis points in just three days.
Short positioning in eurodollars, which are highly sensitive to the path of Fed rate hikes, is near record levels with both real and fast money extending hawkish bets, according to the latest CFTC data.
These moves have been driven by Fed speakers saying this week that rates will need to rise soon. First Fed dated overnight-interest-rate contracts have priced in close to 80 percent odds of a March increase, based on Fed effective rate of 0.66 percent. Other measures of market-implied probability approach 90 percent.
The dollar hit its highest level in more than six weeks on Wednesday morning, amid a sharp increase in bets that the US Federal Reserve will raise interest rates this month.
The dollar index hit 101.78 on Wednesday morning, its strongest level since January 12th and a 0.3 per cent rise on the day, following hawkish comments from an influential member of the Federal Reserve’s policy-setting board.
The probability that rates will rise when the Federal Reserve meets this month shot up from 50 per cent to 80 per cent yesterday after William Dudley, head of the New York Federal Reserve, said that the prospects for adding to the December 2016 rate increase had become “a lot more compelling”.
His comments helped the dollar to overcome a lacklustre reaction to President Donald Trump’s first speech to Congress last night, which outlined plans to ask for $1tn in infrastructure spending – which would be a boost to the US economy – but was lacking in detail some investors had hoped for.
The rise in the dollar sent the pound to its weakest level in more than three weeks at $1.2348. The US currency was up 0.7 per cent against the Japanese yen at Y113.5 while the euro fell 0.3 per cent to €1.0544.
The odds of a March rate increase jumped to 70 per cent on Tuesday after the influential head of the New York Federal Reserve said the case for policy tightening had become “a lot more compelling”.
Bill Dudley said in a interview with CNN International, the television network, that data released over the past couple of months have shown that the US economy is on a solid trajectory, and the central bank is more confident now that it will continue to brighten.
“It seems to me that most of the data we’ve seen over the last couple months is very much consistent with the economy continuing to grow at an above-trend pace, job gains remain pretty sturdy, inflation has actually drifted up a little bit as energy prices have increased,” he said, according to a transcript posted by CNN.
Mr Dudley, who votes on the Fed’s policy-setting board, added that he reckons fiscal policy will “probably move in a more stimulative direction” — an allusion to the tax reductions and infrastructure spending push promised by US President Donald Trump.
John Williams, president of the Federal Reserve Bank of San Francisco, says that an interest-rate increase is “very much on the table for serious consideration” by the central bank at its upcoming meeting in March.
The remarks — which came in the text of a speech set to be delivered on Tuesday to business leaders in California — sent investors’ expectations climbing. Fed funds futures signalled that investors are now pricing in a 56 per cent chance of an increase at March, up from 52 per cent earlier on Tuesday, and 36 per cent a week ago, according to Bloomberg calculations.
Mr Williams cited a strong outlook for the economy, which he said was in its eighth year of expansion with the workforce at full employment and inflation zeroing in on the Fed’s 2 per cent target. A rate increase would be one tool Fed policymakers could consider to help keep that momentum going, he said, according to a text of his prepared remarks.
Mr Williams is an alternate voting member of the rate-setting Federal Open Markets Committee, he has recently taken a hawkish tone in his public appearances, arguing that gradual increases in rates could help keep mitigate the hazards of an overheating economy, particularly given employment levels.