As noted yesterday, Bloomberg trading commentator Richard Breslow refuses to jump on the bandwagon that the Fed is hiking right into the next policy mistake. In fact, he is pretty much convinced that Yellen did the right thing... she just needs some help from future inflationary print (which will be difficult, more on that shortly), from the dollar (which needs to rise), and from the yield curve. Discussing the rapidly flattening yield curve, Breslow writes that "the 2s10s spread can bear-flatten through last year’s low to accomplish the break, but I don’t think you get the dollar motoring unless the yield curve holds these levels and bear- steepens. Traders will set the bar kind of low and start getting excited if 10-year yields can breach 2.23%. But at the end of the day we need another 20 basis points for the entire narrative to change."
To be sure, hawkish commentary from FOMC members on Monday (with the semi-exception of Charles Evans) and earlier this morning from Rosengren, is doing everything whatever it can to achieve this. Here are the highlights from the Boston Fed president.
- ROSENGREN SAYS LOW INTEREST RATES DO POSE FINANCIAL STABILITY ISSUES
- ROSENGREN: LOW RATES MAKE FIGHTING FUTURE RECESSIONS TOUGHER
- ROSENGREN SAYS REACH-FOR-YIELD BEHAVIOR IN LOW INTEREST RATE ENVIRONMENT CAN MAKE FINANCIAL INTERMEDIARIES, ECONOMY MORE RISKY
Ah yes, the "Dudley paradox" in which suddenly low rates are bad for the economy. Thanks for telling us, Fed.
Anyway, beside rates, Breslow says - and we agree - that the market will need one more thing:
"What you need for a true dollar bounce is a half-way decent inflation print, of any sort, coupled with a break of the two-year Treasury note above 1.40%. Doesn’t seem like a big ask, but it needs to happen."
It may not be a "big ask", but it is one which has to be directed at Beijing, which as we have repeatedly shown is the primary driver of the global inflationary impulse, and which in recent months has crashed at the fastest rate since the financial crisis. In other words, for the Fed to be "right", China will have to be willing to risk another modest economic overheating and end its deleveraging ambitions, if only for the time being.
Here is Breslow's full note.
The Dollar Needs Bonds to Get With the Program
I’ve read a number of dollar bullish pieces today. The pendulum is swinging. Wasn’t it only last week that everyone was telling us that the market was fading the FOMC’s “policy error?” That there was no way they would meet their rate hike forecasts? Well, a couple of 21-day moving averages later and traders are getting ginned up. I confess to having a lot of sympathy for the view. I’m not in the it was a mistake camp. But you need to ask yourself what it’ll actually take to make it so beyond a few days of it not imploding.
Just keep reminding yourself that we’ve seen these prices before and something needs to have actually changed for us to break into new territory. The trends we’ve had, haven’t been where people were looking.
It’s tough to argue that the economy is cooling, inflation is weakening but rates will begin to propel the dollar. They haven’t done it yet under that duality. What you need for a true dollar bounce is a half-way decent inflation print, of any sort, coupled with a break of the two-year Treasury note above 1.40%. Doesn’t seem like a big ask, but it needs to happen.
The 2s10s spread can bear-flatten through last year’s low to accomplish the break, but I don’t think you get the dollar motoring unless the yield curve holds these levels and bear- steepens. Traders will set the bar kind of low and start getting excited if 10-year yields can breach 2.23%. But at the end of the day we need another 20 basis points for the entire narrative to change.
The Fed will continue to talk tough, President Charles Evans notwithstanding. They are motivated hikers and are praying the numbers don’t make them look incautious. If you disagree with the dots, do it based on economics not on their perceived level of seriousness.
Governor Carney just told us he has a deeply split committee that won’t be going anywhere too fast. He may actually have a problem on his hands and needs to stay out of the Brexit debate.
President Draghi is going to delay revealing his plans for as long as possible but that’s because he’s going to have a hard time convincing the council to remain as dovish as he’d like. And he won’t get any backing from analysts who will continue to push the “Europe is back” theme.
Governor Kuroda has no appetite for doing anything that causes the yen to race higher. Same goes for the other developed market governors. Re-read SNB President Jordan’s comments from this morning.
On another front, keep a close eye on gold. It is sitting on important support at 1,246 and if it breaks down, dollar bulls will get excited. If it holds, more of the same.
The best part of nascent dollar strength is it will keep things interesting, despite the time of the year, and has an optimistic feel about it. Which definitely isn’t a bad thing under the circumstances.