The financial press is filled with articles about the recent EURO weakness. During the last week the EU currency has fallen about 1.5 percent. Many pundits have opined that it is the Ukraine situation and Gaza that have made investors uneasy, thus the move into U.S. dollars. In a July 22 Bloomberg article, “Draghi Cedes Euro Control to Yellen on Fed Bets,” it is suggested that the DOLLAR is rising in anticipation of moves by the FED, especially now that the ECB has gone to negative yields on reserves. The problem for the Fed argument is that yields in the U.S. have actually softened during the last week and Fed communication has been muddled over when interest rates might possibly rise. When the ECB announced a negative interest rate June 5 the EURO/DOLLAR made a low of 1.3503. Today we are trading at 1.3465, a little below the 1.35 low but well below that day’s close of 1.3650.
Alfred E. Neuman, the beloved character of Mad Magazine, was famous for his deadpan look while espousing the philosophy, “What, Me Worry?”
While the world has certainly entered the madness zone, the world’s equity markets remain in bull mode, floating on a sea of central-bank provided liquidity. Russian support and arming of “rebel” groups results in the downing of a commercial airliner … no problem. An Israeli invasion of Gaza to thwart the nihilistic behavior of Hamas, and the markets shrug and offer up a bland response of, “whatever.”
First, as I have been critical of Chair Yellen’s communication efforts prior to this weeks Congressional testimony, I will give the Chairwoman an A+ for her effort this week. She was very forthcoming in her Senate appearance on Tuesday, and, more importantly, she fended off the idiots in the House of Representatives with clarity and the patience of a saint. The problem with the House is too many ex-prosecuting attorney’s who all try to get Yellen in a gotcha moment, but the Fed Chief was not falling for the trap of providing sound bites for the elections back in the home district. The Senate questions were of a substantial nature while the House was fluff of either adulation or criticism.
Today on CNBC Rick Santelli brought up an issue that NOTES FROM UNDERGROUND has been discussing since Fed Chair Yellen spoke at a Chicago Fed Conference when she placed the names of three long-term unemployed people (as if the Chairwoman’s speech was a State of The Union Address). It is wrong for a Fed Chair to bring moral philosophy to the conduct of MONETARY POLICY IN A FIAT CURRENCY WORLD. The Fed’s role is to preserve the DOLLAR as a store of value even with the DUAL MANDATE. The United States bears an exorbitant privilege with the dollar as the world’s reserve currency, with all commodities priced in dollars. The exorbitant privilege comes with an exorbitant responsibility and that is the maintenance of the DOLLAR AS A RELIABLE STORE OF VALUE.
There’s a little levity during a very stressful week of trading. Germany meeting Argentina in the World Cup final is symbolic of the battles being waged by the world’s central bankers. Jeremy Stein and the BIS view the threat of financial stability a potential concern of Janet Yellen and Mario Draghi. The world’s financial markets will be watching to see what style of play on the pitch prevails: The aggressive Argentinian speed or the more AUSTERE and supreme defensive style of Germany. In the spirit of global macro humor I ask these questions:
- Will presiding referee Thomas Griesa issue a RED CARD to the entire Argentinian team for defaulting on its debt?
- If the Argentinians get control of the ball will someone from Elliott Associates come and grab it as Griesa deems it an asset of the debtors?
- If Argentina prevails, will the trophy be confiscated and given to the intransigent creditors for sale on E-Bay?
- Will Griesa suffer the slings and arrows of outrageous fortune as he is deemed by FIFA to be a biased American judiciary with no genuine knowledge of the international beautiful game of debtor/creditor?
***The question to which we keep returning: ARE THE WORLD’S CENTRAL BANKS THREATENING THEIR CREDIBILITY? A corollary question: DOES THE FED UNDERSTAND ITS OWN FALLIBILITY? As yesterday’s FOMC minutes revealed, confusion reigns within the FED as to the strength of the real economy, especially in ways to measure the OUTPUT GAP of the employment data. How much slack exists in the labor pool to prevent a dramatic rise in wages is of paramount importance for the Fed’s “forward guidance” (and signaling to markets future FED intentions). The FED speaks with great confidence in its projections but if past performance is a guide investors should treat all Fed projections with skepticism. It was the highly regarded Ben Bernanke who maintained well into late 2007 that the housing slowdown was well contained and should pose no problems for the U.S.economy. Yet, the impact of the U.S. credit crisis was severe enough to effect banks and bondholders across the globe. The bottom line is that the FED is fraught with failings and for investors to treat all Fed releases as pearls of perfection should proceed with caution.
“Ms. Yellen told us that policy under her leadership is not rules based. As such, market participants have to rely on the Fed’s ad hoc assessment. And that is very much like reading tea leaves, as the Fed is looking at backward-looking indicators such as the most recent unemployment report. Forward-looking indicators, such as the yield curve, are less reliable as the Fed itself has actively managed gauges. That, in turn, forces market participants to try to read Ms. Yellen’s mind. Her statements make it clear that her focus is on keeping rates low to help promote job growth until inflation readings get enough over the targeted 2 percent level to warrant concern in her mind.”
Tomorrow the Bank of England’s Monetary Policy Committee meets to decide interest rates. Governor Mark Carney has recently confused markets by saying that interest rates would probably rise sooner than forecast. Then Mr. Carney changed directions by following the FOMC and suggesting that the slack in the labor market would allow the BOE to stay the present course and keep interest rates at present levels for an extended period. Overnight rates are currently at 0.50% and with the British pound strengthening against most currencies the BOE is expected to maintain the status quo.
The release of Thursday’s U.S. employment data synchronized with ADP’s private sector report of 281,000 jobs created. The Department of Labor had a gain of 288,000, including the strongest growth in government jobs since the onset of the great financial crisis. Being that July 3rd had very limited volume because of the holiday weekend, it was difficult to determine the genuine nature of the shortened trading activity. Thursday did see a rally in the SPOOs, a strengthening in the U.S. dollar and a downside correction in the precious metals. The most difficult market was the interest rate and yield curve. The immediate reaction was a sizable selloff in all interest rate tenors but by day’s end the LONG END recovered and the 2/10 was a bit flatter. Yesterday saw a correction in the SPOOS as some analysts now believe the FED will bring the projected hike in interest rates forward to a rise in the second or third quarter of 2015.
Today’s release of the ADP report caused the market to react in highly predictable fashion. ADP data predicts a nonfarm payroll in the high 200,000 and as to be expected the BOND FUTURES were sold on the positive outlook, resulting in a STEEPENING in the 2/10 yield curve, a rally in the U.S. DOLLAR and leaving yesterday’s SPOOS rally intact. The only non-correlative trade was the precious metals and copper as both sets of ELEMENTS rallied, defying the implications of potential higher interest rates. Tomorrow will be important in seeing how the market reacts to the jobs data. BE PATIENT. Here’s why: