Notes From Underground: Will the Dollar Make It Into the FOMC Statement?

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.

U.S. 2/10 Yield Curve

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.

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15 Responses to “Notes From Underground: Will the Dollar Make It Into the FOMC Statement?”

  1. Blacklisted Says:

    …and why exactly does the FED have a 2% inflation target, and who benefits? What is the long term consequence of such dollar debasement, especially when wages will remain stagnant until true reform is forced on govt.?

    So far, what a 2% inflation target (which has really average around 3%) has meant is that over a 45 year working life (20-65) a dollar saved at 20 is only worth 26 cents!

    It must be enjoyable figuring out what the inmates will do next.

  2. Joe Says:

    So, if the Fed now talks about the DOLLAR, can we assume that there’s been an official policy reversal under Chairperson Yellen of the Bernanke policy that insisted and testified that the DOLLAR was strictly the domain of Treasury?

  3. Yra Says:

    Joe–no I wouldn’t go that far–but it will just become the excuse de jure.It will fit well with many ceo’s claiming that they are missing earnings because of the strong Dollar—well you asses who get paid such huge salaries as hired guns isn’t part of your job to analyze the global scene and prepare—when the dollar was weak and aiding foreign sales I failed to see you take less salary because you were being helped by the tailwinds of a cheap currency.I don’t believe that Janet Yellen is as “hawkish” as Larry Kudlow has been maintaining —until wages rise far more then the cost of living she will try to keep interest rates and the real yield as negative as possible—the headwinds coming from a strong Dollar—will allow the Yellen fed to sing Hallelujah

  4. kevinwaspi Says:

    “0044 GMT [Dow Jones] The Singapore dollar collapsed to a new 4.5-year low of 1.3570 versus the U.S. dollar after the central bank unexpectedly announced a shift in monetary policy. The Monetary Authority of Singapore in an unscheduled announcement Wednesday adjusted lower the slope of its currency appreciation band–the tool by which the central bank adjusts monetary policy–after downgrading its inflation forecast for 2015 due to weak commodity prices….”

    I do not see how the fed can consider raising rates as we enter the 5th inning of this competitive devaluation race to the bottom. Imagine another day like seen today on wall street with CAT, MSFT, PG, and every other “important” corporate contributor screaming about a higher buck. Just a thought…
    Oh, and on inflation; game over. The local station here in Pottersville skipped from $1.88 to $2.08/gal unleaded on today’s oil move. I’ll call that a 10.6% rescission in my “consumer’s tax cut” of lower pump prices.

  5. Alex F Says:

    If she doesn’t change a thing and ECI is strong, the world will get excited for a June hike.

    The question is how high is the bar for a dovish surprise?

  6. yra Says:

    alex–good point but let’s see the wording —if no mention of externalities it would keep a june hike in play—just my opinion

  7. Chicken Says:

    Extend and pretend, indeed. Scraps for the peasants, let them eat cake!

  8. Chicken Says:

    Climate change is the clear winner of the central banker plan for contracting global growth.

  9. Chicken Says:

    The curve seems to be getting flatter, due to the long end rates falling I think? Wouldn’t a bull flattener involve short end rates rising?

  10. Chicken Says:

    Perhaps JPM disappointed their high net-worth clients with their measly SNB scalp, apparently they were promised a much more lucrative payout.

  11. Chicken Says:

    I didn’t realize the shadiness that is Kissinger. This guy was the architect enabler of Pinochet’s rein of terror and corruption (and a long laundry list of other questionable actions).

  12. SacredReich Says:

    Chicken –Yeah, or in other words is a U.S. econ “expanding at a solid pace” strong enough to resist int’l headwinds? Absolutely correct: Why do 10s fall 23bp on 6 days when jobless claims come close to 15yr low? Does any biz cycle matter for 10s (with fed funds at 13bp level on avg for 6 yrs, haha, six years!)? Phew! As German FinMin said in India: we need higher, stiller higher growth in emrg mkts. Citius, altius, fortius! So, flood them — the Indonesians, the Indians — with credit today to continuously buy Caterpillars and BMWs. Go, plunder their future! for our sought-after relief as, unfortunately, Iceland is already indebted/discredited. More and more, I see FI mkts affected again by real (hard) econ: global imbalances. (This time perhaps structurally driven, whereas pre-2008 was sort of cyclical? Phew!) Another question is whether a credit binge can be launched with a strengthening dollar.

  13. yra Says:

    chicken–see Christopher Hitchens for an indepth look at Kissinger–I was never a fan–Allende Si,Junta No

  14. yra Says:

    Chicken–a bear Flattener would be the short yields rising faster then the long end—such as the initial flattening of the U.S. 2/10 as the two year future dropped while the ten rallied

  15. Yra Says:

    Reblogged this on Notes From Underground.

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