Back to work ..... anything new going on? As it happens, there just might be ...... even if many are unconvinced.

31st August 2016

Back to work ..... anything new going on? As it happens, there just might be ...... even if many are unconvinced.

ref:- "How perceptions of a doveish Fed are reigning in the dollar", The Financial Times, FT explainer, Markets and Investing.

10 days away somewhere remote with only intermittent communications and a brain functioning in similar fashion ..... blissful! Trouble is, it can be a bit daunting trying to catch up with everything upon return. It's particularly fortuitous therefore that the FT has chosen today to put out what amounts to a round-up of recent action in the Dollar and US rates (one reliant on the other), and a tentative prognosis of what might be in store for both.

First, the year in one paragraph (we know ..... we haven't been away that long, it just feels that way) : USD entered the year strong, with the US$ Index close to 100, but by May had tumbled below 92. Market panic and safe-haven buying of Jap Yen was a factor in the move, but more than anything it has been Fed caution towards further rate rises after the December 2015 hike had seemingly signalled more to come that has characterised the year. As we write, the US$ Index is attempting to break up out its recent trading range of 94 - 96 on the back of a more-hawkish-than-usual  (but still non-committal) speech by Fed Chair Janet Yellen last Friday, which suggested that the case for a rate rise had strengthened. It was followed by a more characteristic contribution from her No.2 Stanley Fischer, who was bold enough to mentioned the possibility of TWO hikes this year.

Never mind a gentle look at the upper limits of recent ranges, surely that should have been enough to send the Dollar skywards and US yields in a similar direction ? Once upon a time it no doubt would have been, but the market has become sceptical about the Fed's determination to match words with deeds, as the FT puts it. If the Fed really is "data-dependent" (remember that old chestnut), the hawks would argue that the Fed already has enough reason to act, and postponing doing so betrays a lack of conviction. It also undermines another of our bugbears, the much-trumpeted "forward guidance", which is a fine idea in principle but just now isn't doing much of a job in guiding anyone anywhere.

Moves on US yields would seem to be even more dismissive of rate hike speculation. The sell-off in Treasuries and spike in yields that immediately followed Friday's hawkish words from Yellen and others have given way to a more cynical appraisal. Yields hit a 2-month low on Monday  --  hardly consistent with an imminent rate rise. Falling long-term yields across global markets have a lot to do with it of course, as does a perception that the yield-curve will keep flattening. In other words, short-term rates may be marked higher but that doesn't mean that yields at the longer end have to climb. And if the curve flattens towards little or no premium on the returns of longer investments, that doesn't say much for the chances of consistent, long-term , inflationary growth.

"Hang on a minute! I thought you said things might have changed?" Well, we would agree that at face value it wouldn't appear so  --  chances of a September rise still heavily odds-against, and little better than 50/50 for one in December. According to Fed Fund futures, the probability of a September move is 34%, DOWN from36% on Monday and 40% immediately after Yellen's remarks on Friday. On the other hand, it's a lot more likely that the 18% probability that it was ascribed at the beginning of the month, and the 0% it was given in the post-Brexit meltdown. And it may not be by much, but a move this year is now more probable than not.

The bolder line taken by senior Fed officials, rather than by any of the long-standing hawks, does seem to us to be significant and to represent a change in mood from 10 days ago. Of course it won't mean anything at all if the data doesn't play ball, and with that in mind the Aug employment numbers RELEASED THIS FRIDAY are going to be even more crucial than normal. With other data being a little mixed (consumption numbers strong, inflation numbers iffy), you feel that the release will have to be considered robust at the very least for there to be ANY chance of a hike on September 21st. So, look out for:

Non-Farm Payrolls : expected +180,000 (last +255,000)

Average Hourly Earnings MoM : expected +0.2% (last +0.3%)

Unemployment Rate : 4.8% (last 4.9%)

In truth, all we can really say is that according to the markets the case for a September hike is somewhat more likely than it was but December is still favourite. But that wouldn't make much of a headline and more to the point it may underestimate the pressure on the Fed for a change of thinking. We know all about the Fed's caution and it's data-dependency (Oh God, don't we know about data-dependency !). We also know about its perceived duty to warn investors of all possible options. But it seems to us that the Fed is facing a credibility problem  --  it can't keep saying one thing and doing another ..... not forever, surely? We'll know more about that after Friday, and about whether things really are looking different or not.