You Can’t Have What You Can’t Catch

Perhaps the FOMC’s dovish policy decision and subsequent market reaction is symptomatic of yet another half-baked preoccupation bearing glaring comparisons to the many deflationary risks we’ve been force-fed since early fall.

Perhaps the knee-jerk Fed was more accommodative than anticipated – dismissing any thoughts of an April rate hike while placing thoughts of June further out to pasture. Yet, it may be we are overly reactive liken to our fixation with currency revaluations, the easy accommodation of 20+ central banks, the unrelenting strength of the U.S. dollar, along with dwindling U.S. equity earnings estimates.

Make no mistake about it, market moves have been both oversized and outsized; the point to me is crystal clear in that we are duped into thinking perhaps these moves really mean something, while we have scales over our eyes to the truths that all of this fractured narrative is perhaps part and parcel of a global growth recovery in process.

Fed Chair Janet Yellen’s language did make it clear the central bank needs to see further improvement in labor trends, dropping “patient” for “reasonably confident”, appropriately downgrading the Fed’s growth and inflation outlooks, while hedging herself with the proclamation to once again reinforce data dependency language.

The Fed’s large drop in median dots and dip in PCE core forecasts (i.e. the Fed has recognized that the markets expectations for growth  and inflation are lower than theirs thus the drop in “dots”) did marvels to close the circle on her dovish tone. That caused markets to breathe a sigh of relief while sending two-year Treasury yields down 12 basis points (bps.), the U.S. dollar down 2% against its other accommodative kin (e.g. Australian dollar, Swiss Franc), while almost 3.5% against the Euro!

Petroleum markets responded with WTI +4% while gold – after spending months in the mire - was lifted 2%.  As been the case for months, the stock market went into frenzy – the S&P 500 completing a near 50-point range – closing near the higher end of its recent broad and volatile trading range.

Between Thrusday and the June FOMC meeting, we will be forced to interpret and extrapolate three Consumer Price Index numbers (CPI) and Bureau of Labor Statistics (BLS) – both of which could very well set the table for the Fed and its ultimate intentions to normalize interest rate policy.  Below, is a look and “bottom line” on staying the course with regards to interest rates and the U.S. dollar.

Interest Rates

Market expectations have been appropriately reset to where Fed fund futures are now expecting a 33 bps increase by year end dropping from 40bps yesterday and near 50bps after last month’s labor report. The odds of a June hike have faded as well where presently Fed fund futures are pointing to a meager 24% chance of a 25bps increase while the chances of a June increase have stumbled to near 65% likelihood.

Bottom line: U.S. yields made a steady climb after the last labor report a few weeks ago and now have settled back near one month lows.  Consensus will be skeptical of any economic data and foreign purchases will act like a formidable headwind yet, my best thinking is to go against the grain and expect 10-year yields to be closer to 2.50% by the end of this year.

The U.S. Dollar

Over the last six months, the U.S. dollar has moved so far and so fast – sometimes the U.S. dollar index appears to be in early stages of morphing from a compelling generational investment into a questionable one unless the Fed can figure a way to deliver interest rates above and beyond our wildest imaginations over the next few short years.  The change from Wednesday to Thursday is a phenomenal example of such whereas the U.S. dollar action post-Fed meeting has almost completely undone itself overnight, with the EUR/USD back near $1.07 after spiking to near $1.11!

The bottom line: Consensus enjoys clinging to the age old “floating exchange rate theory” in that a stronger currency will beget weaker imports, higher imports, and thus eventual economic disaster yet, there isn’t credible proof that the Japanese Yen’s three-year weakness against the U.S dollar has done anything to compromise that acute balance between imports or exports.

I would suggest the same would hold true for the Euro.  That said, I do believe the U.S. dollar is overpriced – perhaps 10%-20% so against the Euro in particular and would take advantage of that through the purchasing of cyclical stocks in Europe.  The European stock market has definitely outperformed the U.S. however, in currency terms, it’s basically flat on the year.