The curious case of the rising US Dollar

Plenty of reasons have been given for the resurgence in the US Dollar. A plethora of Fed speakers have been keen to tell us that December is definitely ON. Pricing for a hike in Dec has been happily heading well above 50% since the month began, and on some measures hit 75% a couple of weeks ago:


That’s partly attributable to the return of inflation and also to the declining probability of a Trump Presidency (Nate Silver now sees it around 15-20%).

So far, so good. But the US Dollar has accelerated of late. In some respects, it is just catching up, when it comes to EUR/USD, with where the rate spreads suggest it should be – the white line has been too elevated in the past couple of months compared to interest rates:


But is there something else at play here? Are we starting to see the year-end Dollar hoarding begin already? Or some pre-election risk management? We already know that fund manager cash levels are their highest since Sept 11th 2001…. Either way, let’s not forget that FX is all about the benjamins – and flows into cash might be playing their part


Poor old Mario Draghi. Yesterday his tone was basically irritated. He admitted they might do more QE, but snapped they hadn’t talked of a taper. Equally it’s all data dependent and even the QE extension needs a bit more of a look. Just look at the response he gave when challenged about market impact of his comments:

“I’ve seen the market reaction, and that’s why I said that the Governing Council is the ultimate decision-maker that will use the input from the committees as one of the inputs in the discussion. So that’s why I said that. Was that expected or not? It’s very difficult to answer about my expectation of a market reaction following kind of a random statement made by somebody who didn’t have any clue or information about that.”

In other words, leave me alone.

But why is the market paying any attention anyway? They’ve got no idea, so why should we? The boJ aren’t much better, with kuroda admitting they might need to buy fewer bonds to maintain 10yr yields at zero percent. No wonder volumes in that market have halved since their announcement?

irritated? I’d say so…


The hiatus continues – by which we mean that warning signs are building, even as market volumes are light. Yet again, we are already panicking ahead of the panic. The latest BAML Fund Manager survey shows cash levels climbing again – now reaching the highest allocation to cash since 9/11. So what’s left to liquidate? Well… let’s all hail the new tail risk on the horizon… shooting up the charts, out of nowhere last month, zooming into the top 3 concerns for the world’s fund managers, it’s: “Crash in Bond Market / Rising Credit Spreads”. Perhaps Donald Trump should take note that the bond market can even bully him, with “Republican Winning the White House” pushed down into third place.

So, with this risk on the horizon, and cash levels so high, does this mean that investors have already enacted this panic? Markets tend to rehearse various scenarios as they become more probable – but then fall back quickly once the reality does not keep up with the expectation. In such a way, the Euro didn’t disintegrate, the Greeks didn’t exit, the US debt ceiling didn’t implode and Brexit didn’t (yet?) kill the UK economy… and so on and so on. With volatilities so depressed via the combination of central bank intervention and a virtuous circle of ‘low returns means more risk taking means lower prices for risk means lower returns means more risk taking’….. is it any wonder that the snapback to reality is happening ever quicker these days?

So for this to break, we need a shift in the expected future path of the world. Sometimes that comes because of an event. In the past we have had examples such as QE is unexpectedly announced / Russia invades Ukraine / OPEC fail to reach an agreement, etc. New information is presented to us.

But sometimes it can be a shift in the perception of the information that we already have. For so long we have been suckling on the cheap money teat of our benevolent central bank guardians that we don’t want to think it could ever end. In fact, we can’t think it. It’s a risk that fell off the radar. But take a look again at that “tail risk” chart. A new entry at no. 5: it’s “Tapering by ECB/BOJ”. Ironically, this is now as big a risk this month as “Helicopter Money” was last month! That kind of swing in sentiment is what happens when a change in perception begins. It’s small at first. It niggles at the back of your mind. A few people might mention it to you. You dismiss it. Everyone is buying risky assets and you need to get involved! Ok so what do you do as the niggle gets bigger… you put aside some cash to protect yourself. Now that’s like a pill for the niggling headache – it makes you feel better in the short-term but long-term can you really shift the concept that the world might be changing? That actually, it was always insane for corporates to begin to issue at negative interest rates? That the free money wasn’t doing anything aside from harming bank profitability? That the politicians now need to take over?

That this is, in fact, The End of Monetary Policy?

We may not want to believe it, but at least now we are entertaining it. What would prompt a further shift in perception? Well, step forward Mr. Draghi, in tomorrow’s un-eagerly un-anticipated ECB meeting. EUR/USD breakeven is 75 pips. That pretty much means hardly anything is expected.

Time for the Taper Rabbit to emerge from the hat?

Why is nobody listening to this?

Given the propensity for market noise, whether the fictitious application of a narrative to suit the particular cognitive dissonance, or simple chitter-chatter, it is always surprising to consider what is not being talking about.

Exhibit A… Stan Fischer’s speech yesterday. Yes, yes, OK so he gave no comments on the short term direction for interest rates, as the many news providers like to summarise it:

But hold on there a moment. Does that mean he said nothing relevant? For a start, he flagged up that he’s “not enthusiastic” about shifting targets given they are “very close” to their inflation and employment targets. He then went on to give a very detailed quantitative analysis of how various factors are depressing the long-term neutral interest rate (Williams’ good old r-star). He goes so far as to include a table, whereby the first 5 factors could reduce the interest rate, and then a couple of suggestions for the last two for pumping it back up again:


He goes on:

“Lower trend increases in productivity and slower labor force growth imply lower overall economic growth in the years ahead. This view is consistent with the most recent Summary of Economic Projections of the FOMC, in which the median value for the rate of growth in real gross domestic product (GDP) in the longer run is just 1-3/4 percent, compared with an average growth rate from 1990 to 2005 of around 3 percent.
We can use simulations of the FRB/US model to infer the consequences of such a slowdown in longer-run GDP growth for the equilibrium federal funds rate. Those simulations suggest that the slowdown to the 1-3/4 percent pace anticipated in the Summary of Economic Projections would eventually trim about 120 basis points from the longer-run equilibrium federal funds rate’

So that means that the current Fed forecasts for 1.75% long run growth means that the long-run interest rate needs to be 120bps lower than you might otherwise expect. That’s 5 chunks of 25bps hikes lower than you might expect.

OK, so you tell me that it doesn’t matter, because a) the market already prices lower interest rates ahead than the Fed; b) that’s a real rate of interest, and if inflation picks up then it does the job for them; and c) in the long run we are all dead so who cares?

Because, my distracted friends, it means that the current ~70% pricing in of a rate hike in December is almost irrelevant. This increased expectation of a hike has been blamed for the 2%+ rally in the USD since the start of the month. Which in turn has been blamed on the receding prospects of a Trump Presidency and therefore the Fed can get on with things. But it doesn’t really matter when they go, because when they start, they’re not going to go very quickly. All of these speeches are designed to neutralise the alleged pain of a rate hike. Don’t get too carried away, that’s the mood music from the Fed. As well they might, because with inflation coming back, and the market starting to sense The End of Monetary Policy, longer term interest rates are starting to spike. Now, we might not believe them, but at some point the market is going to take notice of this mood music.

Which leads to Exhibit B….

The US election mood music. Sure, the likelihood of a Trump Presidency is now just 15% according to venerated pollster Nate Silver. Blondemoney is a fan of anyone who has done well with their predictions, but let’s not forget that Silver himself already admitted he got the Trump candidacy wrong. The Americans keep telling BM that their polls are amazing; they are nothing like their poor UK equivalents. But after the widespread condemnation of those Trump comments about women, do you think maybe at least some people are starting to lie about their votes for him?

All is not as it seems. For once, it’s not about the noise. It’s about what lurks in the silence.

Slowly slowly catchy breaky

After a hiatus of her own, Blondemoney returns to find one stand out fact. Not an awful lot has happened (aside from some more GBP histrionics), so why on earth is the Vix jumping out in our classic cross asset vol chart?


In these vol-compressed wall-of-money buy-the-dip days, even a 2% down move in stock indexes would be a serious event.  But do these numbers suggest that anything much happened? sp-moves-last-week


So then we go back to our other latest indicator of potential volatility ahead. Curves. (Blondemoney always a fan of these). Our 5s30s chart is indeed showing some more steepening:


Sure, Yellen told us again at the weekend that she’s not that bothered about inflation. But we already knew that didn’t we? And that the ECB might be starting to waver and look at tapering? Sometimes, we may already know all of this, but it’s the drip drip drip that starts to wear us down…