So just how many swallows do make a summer, then? Data dependency revisited..... well, sort of.

Wednesday 20th July 2016

So just how many swallows do make a summer, then? Data dependency revisited..... well, sort of.

ref:- "Dollar Near Six-Week High as U.S. Data Surprises Renew Fed Bets", Bloomberg

We were discussing only the other day how some policymakers have taken to describing their decision-making process as one that will be "data-dependent", as if their predecessors had somehow adopted systems that weren't. To a very large degree, ALL policymakers are, and always have been, reliant on the data reflecting current conditions to inform their decisions. Our point was that if you constantly stress your data-dependency, something that should be taken for granted, you run the risk of encouraging large market over-reactions to individual pieces of data that may or may not mirror the true situation.

But what about a series of data releases that seem to point in the same direction? Is it okay to start drawing conclusions then? Well, that's always a judgement call of course but it seems that there's a growing body of opinion taking the view that recent US statistics do point towards an underlying trend that increases the chances of a rate hike this year. The high-profile and very bullish employment numbers that re-ignited enthusiasm for that view have been supported by surprisingly strong reports for retail sales, construction and housing. Fed Funds futures do not yet suggest that a rise in 2016 is now PROBABLE, but it's close and the changing sentiment is reflected in the renewed strength of the US Dollar.

In the widespread panic and doom-mongering that immediately followed the Brexit vote, the markets had the probability of a hike by year-end at less than 10%. As we write this morning, that number has risen to 47%. Is it  legitimate to conclude that recent data reveals an environment in which we are much more likely to see a move this year than we were ? Absolutely it is. Should we be wholly convinced that it's going to happen? Ah .... that's a different matter entirely.

One might want to make a number of assumptions: 1. That these recent numbers are giving an accurate picture of the US's economic health (rather than last month's much more anaemic evidence, for example) .... okay, that's not unreasonable. 2. That the robust picture will continue .... more of an assumption but fair enough given the IMF's decision to retain its forecast for US growth at 2.2% even while it's adjusting other areas lower. 3. That the Fed will make its decision based squarely on domestic considerations without reference to events elsewhere and the dangers they may present .... not a cat in Hell's chance.

Much to the irritation of many in the States, including some in positions of considerable authority, and despite their view that the Fed's original remit means that domestic policy decisions should be made in isolation of the rest of the globe, the Fed has shown itself acutely aware of the global situation and the effect that its decisions may have on it. As by far the most important monetary body in the world, the Fed are plainly aware of their global responsibilities but the "isolationists", if we can misuse the term for a moment, can be too narrow-minded for their own good sometimes. If a mis-step by the Fed causes turmoil in emerging markets for example, that WILL come back to bite the US economy. Very often, the wider view is also the one that best serves the interests of those at home, too.

Wait a minute .... the Fed ignoring domestic economic reports and focussing on theoretical dangers for the world economy in the future? That's the opposite of data-dependent, surely? Well, in the strictest sense, yes. The fact is that central banks have to be both data-dependent, and fully cognisant of all other factors. One wouldn't expect anything else, and it's why these labels are so unhelpful. It's also why things are often more unpredictable than a series of similar data reports might suggest.

As it happens, we wouldn't argue that all other things being equal, a rate hike is becoming more likely this year but then what do we know? Then again, it's not that long ago that the Fed itsef was predicting no less than FOUR rate hikes this year, and that quite definitely is NOT going to happen. If you ever wanted an illustration of how current data is not the be-all and end-all of either policymaking or market prediction, that surely is it.