Monday May 2, 2005 - 11:14:02 GMT
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Black Swan Capital - www.blackswantrading.com
Currencies captive to Fed?
"It was the case that the price level in 1929 was not much different, on net, from what it had been in 1800. But, in the two decades following the abandonment of the gold standard in 1933, the consumer price index in the United States nearly doubled. And, in the four decades after that, prices quintupled. Monetary policy, unleashed from the constraint of domestic gold convertibility, has allowed a persistent over issuance of money. As recently as a decade ago, central bankers, having witnessed more than a half-century of chronic inflation, appeared to confirm that a fiat currency was inherently subject to excess."
Fed Chairman Alan Greenspan Before the Economic Club of New York, New York City December 19, 2002 "Issues for Monetary Policy"
German bund yield at a 4-decade low, while US long bond yields continue to plummet despite the belief the Fed will continue to hike the Fed Funds rate. What in the heck happened to the so-called inflation expectation? It’s looking more and more like disinflation or deflation expectations are ruling the day.
But Morgan Stanley’s Richard Berner isn’t buying it. He thinks there may be a surprise down the road:
“Both equity and bond markets now seem priced for a cyclical slowdown, and market participants are highly skeptical that this soft patch is merely a replay of 2004. Even with some recovery, they expect a muddle-through scenario, and a Fed that will finish its tightening cycle in a few months is now in the price. Thus, somewhat weaker growth probably won’t have much impact. In contrast, the comparatively hearty and enduring economic rebound that I expect would come as a surprise, carrying with it significantly different implications for inflation, for the Fed, for all asset classes, and for volatility.”
Berner’s chalks up the slowdown to three temporary factors:
1) Higher energy prices crimping demand
2) Companies making capital investments ahead of announced price increases, there temporarily accelerating inventory buildup
3) Seasonal distortions in the March data
This week we hear what the Fed has to say and we get payroll numbers on Friday. So, it could be a very interesting week—to say the least. But one of the things we have been watching lately is commodity prices. We’ve noticed the dollar has acted well despite lower US yields—but commodities haven’t acted well at all.
The pattern we are used to seeing is rising commodities on falling interest rates i.e. the reflation or carry trade and a falling dollar. The dollar acted well given the rate background during the week (the only hit was on Friday due to the ongoing belief China is going to revalue the yuan).
If long yields are telling us we are entering a different macro environment i.e. disinflation/deflation, we still believe the dollar could benefit on an intermediate-term basis.
CHART: CRB vs $ Index
Slowdown or not, there is still plenty of liquidity out there. The Fed knows it, and they are unlikely to revisit past sins—using global asset bubbles as a key methodology to boost consumer demand through the so-called wealth effect. (We tend to believe a top in commodities represents more than a US soft patch—it says something about the demand, or a financial bubble, in Asia. It is one of our intermediate-term themes for a stronger dollar—offshore funds heading back to the US; in addition to relative yield and growth.)
Until we see evidence to the contrary, we think the Fed will stay the course of removing “accommodation” from the market, even in the face of a soft patch in the US economy. The bottom-line is: The Fed is behind the curve.
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