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Thursday, April 6, 2017


The dollar index got a boost in the morning yesterday from ADP forecasting a wildly good private sector estimate (263,000) and in the afternoon, the Fed minutes affirming two more hikes this year plus contracting the balance sheet perhaps as early as year-end, which should boost yields. The index spiked to the highest this week. Nothing negative here for the dollar, and yet despite all this good news, the dollar index closed near the low and lower than the open. The dollar index spiked upward overnight but is down again this morning.

The 10-year note yield chart is a little different. We got a high of 2.382% on the Fed minutes, but that dissipated and closed down at 2.352%, about where it was the day before. The WSJ’s excellent bond market reporters writes “The bond market’s recovery suggests that the balance sheet topic hasn’t generated much anxiety among bond investors.” This is nothing short of amazing. The Fed has $4.5 trillion to unload, a vast sum. And the bond boys remain unimpressed. It must be the “show me” attitude. They will believe it when they see it.

In the US

The ISM nonmanufacturing index fell to 55.2 in March from 57.6 in Feb and vs. a forecast of 57. To be fair, Feb had been the highest since Oct 2015 and the March data extends expansion for 87 months in a row. The activity component fell to 58.9, new orders fell to 58.9 and most interesting for payrolls tomorrow, the employment index fell to 51.6.

 Also in the US, ADP forecast the private sector component of Friday’s payrolls at 263,000 in March, far more than other forecasts. Bloomberg has a normal-seeming 180,000. March weather was exceptionally bad and should have cut into job growth. It’s unrealistic to expect a replay of Jan 238,000) or Feb (235,000).

In the Eurozone

ECB chief Draghi poured cold water on the taper idea (again), saying “I do not see cause to deviate from the indications we have been consistently providing in the introductory statement to our press conferences. We have not yet seen sufficient evidence to materially alter our assessment of the inflation outlook -- which remains conditional on a very substantial degree of monetary accommodation.” The euro obediently fell from 1.0679 to 1.0627 in the 3 am hour. It didn’t stay down for long, but jawboning certainly works.

In Germany

Factory orders rose 3.4% in Feb but against a forecast of 4%. Jan had been a decline of 6.8% (revised), so it’s something. Orders are still up 4.3% y/y. Bloomberg reports domestic demand gets the credit, up 8.1%, while export orders had no growth.


The euro remains range-bound despite big data releases all week. The range is a little wider than yesterday, with the 3 am Asian-to-Europe handoff today at a new low of 1.0627 after the 3 am handoff yesterday at 1.0690. The new low in the 3am hour was caused by Draghi jawboning. He said there is not sufficient evidence (inflation) to change policy—i.e., no tapering and please stop talking about it. The net result is a moribund market and that itself is an indicator.

Notice that the Bollinger bands (two standard deviations around the 20-day moving average) are contracting. We have had five days of meandering ranginess and that’s enough to influence a 20-day measure. Contraction in the band often ends with a breakout. We keep trying to make the case that it will be an upside breakout but it’s getting to be an expensive theory.


There’s a world of meaning in a single sentence in the Fed minutes. “Most participants anticipated that gradual increases in the federal funds rate would continue and judged that a change to the committee’s reinvestment policy would likely be appropriate later this year.” The first meaning resides in the word “gradual.” Traders don’t want to hear gradual. They want to hear “full steam ahead and damn the torpedoes.” The Fed hardly ever delivers that one. And what does “gradual” mean? Given the near-promise of two more hikes this year, probably only that May is off the table.

Sure enough, the CME FedWatch tool shows the probability of a hike in May falling back from 5.3% to 4.3% (as of 8 pm last evening). The probability of a June hike rose to 63.4% from 58.9%.

Secondly, the “reinvestment” policy is a fancy way of saying “shrink the balance sheet.” The minutes say “Many participants emphasized that reducing the size of the balance sheet should be conducted in a passive and predictable manner.” This means letting maturing paper go un-replaced. Both Treasuries and mortgage securities will be treated the same. Afterwards, NY Fed chief Dudley told Bloomberg that while the committee still favors three hikes this year, it could start normalizing the balance sheet by year -end or early 2018, and normalization is “a substitute for short-term rate hikes.” Then the Fed could pause in actual hiking.

This scenario has been around for a while, ever since the Fed stopped buying bonds in 2014 but continued to reinvest cash from maturing issues in new auctions. It’s the reinvestment that has kept yields artificially low for so long. With the Fed going away, yields have to rise to attract new investors.

Here’s the problem we face today in looking at the dollar: the economy is not exactly on fire, but it’s not too bad and certainly not pointing to recession. Hope still springs on stimulus from tax reform and infrastructure—to the extent that when House Speaker Ryan said the Congress and White House are not on the same page on tax reform, various markets moved more than on the Fed minutes, especially equities. And the Fed had expressed worries about overvaluation in equities, too.

Then there is the probability of a June hike on the rise, and anticipation of shrinking the balance sheet, however far away, boosting to yields someday. To add icing on the cake, ADP expects a rip-roaring payrolls on Friday, with the private sector alone delivering 263,000 jobs when up to now, most forecasts were well under 200,000.

So why do we see chart indicators pointing to a weaker dollar instead of a stronger one? The only explanation is that good is not good enough. As when the Fed actually hiked in March and yields and the dollar perversely fell afterwards, perhaps this is one of those times when June is too gradual or the boost to yields is too far off in the someday. 

Payrolls tommorow could change all that, but again, ADP set the bar awfully high and the actual is all too likely to disappoint against the expectation, causing a drop even if the number itself is objectively pretty good (such as 170-190,000). And if the number is bad (130,000-150,000), watch out below. 

We hesitate to say the dollar is on the defensive because of geopolitical factors, although the worst-case scenario is developing. Gold is clinging to a level near the 200-day moving average. N. Korea slapped ally China in the face ahead of the meeting with the US by firing another provocative missile. Nobody knows what the US response will be if China declines to rein in its client state. Trump has said the Syrian chemical attack has crossed the red line, or many lines, implying the US should take some action. But he also spent the past several years saying “America First” and the US has no dog in that fight. So which is it? Besides, Syria is in the Russian sphere of influence. They wanted it and we let them have it, but they failed to remove all the chemical weapons as promised. Was the chemical attack inspired by Putin to form the classic first-100-days enemy provocation?

Trump doesn’t have a foreign policy or a foreign policy staff. The State Dept is endless corridors of empty desks. The atrocity in Syria shows he has a heart (narcissists often do not) but that doesn’t mean we will get a new policy stance that runs contrary to America First. It’s still true that we have almost nothing to gain and a great deal to lose by being the world’s policeman. It’s not that we do it badly. It’s that the job can’t be done well short of outright colonization.

Students of colonial history know that in most cases, the colonizer exploited the colonized. But there is evidence that in many places, the colonizer spend more to manage the colony than it ever got back in financial benefits. India is the prime example. The British government spent more than the East India Company made and that situation persisted for decades. It’s noteworthy that India’s government management is exceptionally bad for a country full of smart people. Literacy is low. Public services from clean water to trains that run on time are in short supply. A simple lawsuit can take twenty years to get to a verdict (justice delayed is justice denied). So, even if you colonize a place, you still won’t necessarily get a good outcome.

Trump is not speaking of colonizing Syria. The US partially colonized Iraq and botched it. Besides, some of the bad guys in Syria are backed by the Iranians while the Bad Guy in Chief is backed by Russia. This is too much complexity for the Trump brain to embrace. The NYT’s Blow comes up with another one of his splendid rants. As rants go, Blow is the master. He writes “’I don’t show my hand’ isn’t a strategy to conceal a plan as much as one to conceal the absence of a plan. [Trump’s] statements are all bluster and bungling and bosh. Our commander in chief is not in full command of his emotions or facts or geopolitics.

“We may sometimes think that the absurdity of Trump’s endless stream of contradictions and lies ends at the nation’s borders, but it doesn’t. The world is watching, and the world is full of dangerous men who see killing as a means of maintaining and exerting power. They see in Trump a novice and know nothing, and they will surely test his resolve.

“Trump has exposed himself to the world as an imbecile and burned through American credibility with his incessant lying. Even many of our allies seem confused and worried about where we stand and how we plan to proceed. Trump is full of pride, obsessed with strongman personas, and absent of historical and geopolitical perspective. This is the worst possible situation. The man who could bring us into military engagement is woefully deficient in intellectual engagement.

” It doesn’t matter whether you agree with Blow’s deeply negative assessment of Trump’s capabilities. What does matter is the horrible conflict between the dollar being the safe-haven currency in times of geopolitical turmoil while at the same time it’s the currency of the turmoil-manufacturer. This is an unresolvable conflict. We are worried about the prospect of rising relative yields failing to boost the dollar This could mean only that the yield-setters are unimpressed so far with the prospect of rising yields—or it could mean they see the safe-haven role going into decline because of seriously incompetence at the center of US government.

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