During the first quarter of this year, it seemed like all everyone could talk about was the long US dollar trade. The hedgies had all ridden the trade to great profits and, as usual, all they could do was extrapolate that trend continuing forever. I believed the sentiment was so one sided it made more sense to trade the US dollar from the short side (Apr 06/15 – The coming US Dollar unwind). Proving that even stopped clocks are right twice a day, I managed to get that call correct. The US dollar index corrected from a high of just over 100 to a low of 93 earlier this week.
Most importantly, the speculators have dramatically reduced their long US dollar positions. My home grown indicator of the sum of spec positions in CME currency futures has fallen from a high of almost $50 billion notional to $29 billion.
It’s funny that chatter about the long US dollar trade has disappeared. Nothing has really changed in the fundamental story. The American economy is still nudging towards entering a monetary tightening cycle, while the rest of the world is solidly stuck in easing mode. It just goes to show how prices make the headlines and not the other way round.
This correction in the US dollar bull run might be the pause that refreshes. We have worked off the massively overbought technical picture with the small correction in both time and price. And the sentiment is much more healthy with all the tourists having moved on to other trades.
I am starting to establish some US dollar long positions into this dip. I especially like the Japanese Yen short. During this whole US dollar correction, the Yen could barely rally. The Bank of Japan is still the most aggressive Central Bank out there, and there is a real chance the Yen decline eventually spirals out of control.
As a percentage of their economy the Bank of Japan balance sheet expansion is mind boggling large. And the most important aspect of their monetary expansion is the government’s determination to achieve their economic goals. The Japanese are not plagued with a slew of a different governments with varying opinions about proper monetary policy like the Europeans. No, the Japanese are united behind their leader and committed to breaking the back of the deflationary morass their country has been mired in during the past couple of decades. They are going down the road of “balance sheet expansion until inflation or bust” whole heartedly.
They might well get both, inflation and bust, at the same time, but of all the countries, I have the most confidence in the Japanese sticking to the plan. And it seems like the market is confirming that thesis.
The Yen refuses to go up. The best it seems to do is go sideways.
If we enter into a another US dollar rally, I am hopeful the Yen will lead to the downside.
Market refuses to believe the Fed will hike rates
I continue to be amazed at the sheer number of market pundits who steadfastly refuse to believe the Fed will hike rates anytime during 2015, with many being so bold to proclaim that due to the coming elections, even 2016 is off the table!
Back when the Fed was tapering their QE programs the market threw a tantrum, worrying the end of QE meant the start of a stair step move higher in rates at every Fed meeting. This is how Greenspan did it during the last tightening cycle, and (as usual) the market couldn’t imagine anything different. The Fed had to engage in a massive campaign to stress that tapering was not tightening. The end of QE did not mean rates were headed straight up.
It appears to me the Fed did too good a job convincing the market that rates were not headed higher. The Fed has pulled away the football of monetary tightening so often, the market does not believe they will ever follow through.
This has created a dangerous situation for the Fed. They have begun to lose credibility, so the Fed’s signalling has lost effectiveness. This will make the first hike more violent than it has to be.
The market will not believe the hike until the Fed actually follows through. The most anticipated rate hike in decades will be a surprise for many market participants.
The Fed is getting ready to signal higher rates
I think we are going to get plenty of signals the Fed will hike rates. They are going to try to beat the market over the head with clues. And in fact, I think they have already started.
In a great blog post the Humble Student of the Markets highlighted a recent shift in rhetoric from noted dove Fed President Charles Evans. Here is a quote from one of his prepared speeches from a few days ago:
In my view, it likely will not be appropriate to begin raising the fed funds rate until sometime in early 2016. Economic activity appears to be on a solid, sustainable growth path, which, on its own, would support a rate hike soon. However, the weak first-quarter data do give me pause, and I would like to see confirmation that they are indeed a transitory aberration. Furthermore, and most important, inflation is low and is expected to remain low for some time.
But then when asked a question from a reporter, Evans responded with:
Evans, who in his speech argued for rates to start rising in early 2016, told reporters if the FOMC had confidence that inflation was going to move up and that first quarter economic softness was temporary, “you could imagine a case being made for a rate increase in June”.
Although Evans would probably not want to raise rates anytime soon, he realizes (or was told) the Federal Reserve committee is leaning towards a rate hike sooner rather than later. Evans took the opportunity to explicitly set expectations counter to his speech.
Today we will get the release of the Fed minutes from their previous meeting. I suspect the market will once again be surprised at how close the Fed is to raising rates. They have their finger on the trigger. It won’t take much to push them over the edge.
The US dollar rally that scared the Fed last quarter has subsided, the Greece situation will be resolved one way or another shortly, oil has stopped plummeting helping to stabilize many of the countries reliant on that commodity, and the economic weakness from the brutal winter seems to be working its way through the economy. All of these factors add up to a Fed that will hike sooner than the market realizes. That rate rise will be beneficial for the US dollar and it won’t be long before everyone is once again talking about the long US dollar trade.
Thanks for reading,