Yesterday the FOMC met and left rates unchanged. They had a chance to walk back guidance on their insistence of three to four more hikes this year, but they let the opportunity slip by. Although there was some acknowledgement about not meeting their inflation goal, the tone was of staying the course on their hawkish path. The most surprising part of their statement was their cluelessness regarding the state of the economy. From yesterday’s FOMC statement:

Information received since the Federal Open Market Committee met in December suggests that labor market conditions improved further even as economic growth slowed late last year. Household spending and business fixed investment have been increasing at moderate rates in recent months, and the housing sector has improved further; however, net exports have been soft and inventory investment slowed. A range of recent labor market indicators, including strong job gains, points to some additional decline in underutilization of labor resources.

The Federal Reserve continues to look at lagging rear-view mirror economic indicators and claim everything is fine. Meanwhile the US economy is slowing rapidly. Have a look at today’s economic releases:

Durable goods came in at -5.1% versus an expected -0.7%. Capital goods orders were equally bad at -4.3% versus a consensus estimate of -0.2%. Also have a look at the revisions for the previous month. They were all revised down from the previously reported good numbers.

On Friday the US GDP number is scheduled to be released. The American economy is expected to have grown at an 0.8% annualized rate for the last three months of 2015. Hardly the stuff of heady growth. And this figure did not even include the early January period with the equity sell off and all the economic uncertainty accompanied with the decline. It’s hard to see the first quarter of 2016 bouncing hard from the already low growth of the last quarter of 2015.

Meanwhile the Federal Reserve officials all continue to kowtow the line about economic strength and keep reiterating the asinine projection of three to four rate hikes in 2016. Yet the market simply doesn’t believe them. There is only one 25 basis point increase priced into the Fed Funds futures curve out to December 2016. If the Fed is serious about their guidance, then the markets will have some serious turbulence ahead of it. Part of me says not to worry, the Federal Reserve will back down. But what if they don’t? I would have guessed the Fed would have already eased up on the hawkish rhetoric, but so far they have not wavered.

The forward looking indicators are all screaming economic slowdown. It should be absolutely no surprise the US economy is rolling over. It has been clear for some time now.

Don’t get me wrong, I understand why the Fed wants rates to be higher. Wouldn’t it be great if the economy was strong enough to actually withstand the higher rates? But wishing something doesn’t make it so.

Last December the FOMC members who believed “zero rates were supposed to be an emergency policy, and the emergency had long passed” won the day with their rate hike. I get it. They gave it a shot, and it didn’t work out as planned. Lord knows I have trades all the time that don’t work out as planned. But I adapt, and alter my course. This insistence on sticking to their hawkish guidance is intellectually weak.

By the time these clowns figure out the US economy is slowing, it will probably be time to bet the other way. In the mean time, I am buying more US treasuries (and shorting European debt against it).

The Federal Reserve has made the same mistake Japan and Europe did by assuming their economy could handle the extreme currency strength. Each time the country with the strong currency imported all the world’s deflation, and was eventually forced to ease aggressively when their economy tanked. The Federal Reserve is making the exact same mistake…

####Not sure which is the tail and which is the dog…

I stumbled upon a Bloomberg report that highlighted the tight relationship between the S&P 500 and the spread of the March 2016 versus March 2017 Eurodollar futures contract. The Eurodollar futures contract is based on the interest rate at which US dollars are lent amongst banks to one another outside the United States. It generally follows the Fed Funds rate fairly closely.

If you are trading the spread between the March 2016 and March 2017 contract, you are in essence executing a yield curve trade at the front of the curve. As the market expects more Fed tightening, this spread will widen. As this expectation is removed, the spread will narrow.

Enough with the explanations, here’s the chart:

The tight relationship since the new year is undeniable. The stock market and the chances of the Fed tightening over the next year are moving in tandem.

I am not sure if eurodollars are following the stock market, or if the stock market is following the eurodollars. Is economic weakness causing the chances of Fed tightening to be diminished, narrowing the spread and stocks following lower? Or is the stock market plummeting, causing the chances of the Fed tightening to diminish? I don’t know, but it is remarkable how much these two series are trading on top of one another.

Thanks for reading,
Kevin Muir
The MacroTourist