The FED is on the record as being patient as it tries to achieve its dual mandates of full employment and an inflation rate of 2 percent. In the December 16-17 FOMC release, it said the “… Committee expects inflation to rise gradually toward 2 percent as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate.” While the FOMC statement made no direct mention of the DOLLAR’S STRENGTH, the release of the MINUTES revealed that the dollar had been discussed in reference to inflation. The minutes said: “Participants generally anticipated that inflation was likely to decline further in the near term,reflecting the reduction in oil prices and the effects of the rise in the foreign exchange value of the dollar on import prices.”
Since the last meeting, the dollar has appreciated another 8 percent against the euro and other emerging market currencies as well as the Aussie and Canadian dollar but is steady against the yen. Crude oil is approximately 20 percent lower since the December meeting, thus putting further downward pressure on the Fed’s inflation measures. While some analysts maintain that falling energy prices will stimulate domestic consumption I believe the lower energy prices will have a negative impact on overall wages as layoffs in the energy sector will lead to a substantial loss in high wage jobs as well as some drop in manufacturing jobs that supply the energy drillers. There is no Yellen press conference so it will be important to read the FOMC statement to see if the FED actually talks about the dollar and any negative impact from the loss of energy jobs. If the FED actually mentions the STRONG DOLLAR as a headwind I would view that as the Fed moving to push back any interest rate increase. The fact the ECB has embarked on a genuine QE program and the Danish, Canadian and Swedish banks have all cut rates the FED will be careful in sending the dollar much higher.
***After the FOMC meeting, the Reserve Bank of New Zealand announces its overnight interest rate at 2 p.m. CST and consensus is for no change to the present 3.5 percent. However, I am predicting a cut in NZ rates because the 2/10 yield curve in New Zealand is very flat and actually inverted last week, indicating that the RBNZ is overly tight. Also complicating things for the RBNZ is a suspected slowing in China and the Aussie/Kiwi, which has made a 35-year low, meaning the KIWI is very strong versus is main trading partner and Asian competitor. With the recent “surprise” cut by the Bank Of Canada, let’s watch the RBNZ for further hints of fears of a global slowdown.
***Speaking of yield curves, the U.S. 2/10 curve has been flattening during the past 12 months and is now reaching a level I have deemed to be critical. Returning to the day of Mario Draghi’s famous “Whatever It Takes” speech on July 24, 2012, the immediate impact was to end the fear of European insolvency. As the market was calmed, the world’s flattening curves immediately reversed and spent the next 18 months steepening, an indication all was right again in the global financial system. By December 31, 2013, the U.S 2/10 curve had steepened from the low of 117 basis points to 265 basis points, a very steep curve. Now, in the event of slowing global growth, lower commodity prices and declining inflation, the U.S. 2/10 is at 130 basis points having made a 30-month low at 126 points this week. The FED will have to be aware of this and be cautious in raising rates as it will send the curve through the 2012 lows, signaling a potential problem.
Yes, 117 basis points is still steep but the test of the low made during the European crisis is a potential red flag. The German, French and Dutch 2/10 curves are flatter than during the 2012 period. Spain, Italy, Ireland and Portugal–countries with higher insolvency risk in 2012–have seen their curves approaching the same levels of July 2012. Unlike that previous period, this is a bull flattener as 10-year yields are falling, which is putting pressure on the entire curve structure. More importantly, 117 basis points for the U.S. should keep the FED on hold. If the FED discusses the DOLLAR and possible job losses in the oil patch, the 2/10 ought to steepen. Be prepared and have your technical indicators in place.