What if the FED never hikes again?

In the midst of all the discussions over hiking cycles, we have been pushing for the market to consider some much bigger potential questions: nuclear war, impeachments, powerless governments and the like.

Monetary policy divergence is an old story. It was, like many old stories, a good one. It had a comforting narrative and it worked. The US dollar went up as America indeed was on the path to being great again. Money was made as sense was made.

It’s always much tougher in these periods when various new narratives compete to be the driver. It’s still carry versus the economy versus politics. And as the last of these is still woefully misunderstood and unpriced, we are left with the economy and with carry.

There has now been a shift with regard to the economy. Is reflation running out of steam? We warned that Chinese PPI could be on a downward trajectory, and its last print saw it plateauing, albeit at the racy heights of 5.5%. Then US inflation disappointed. Even Uk inflation came in lower than expected today.

But then on the other hand we have carry. As the Bank of Canada showed last week, the carry rankings don’t stay static. When a central bank wants to shift, it shifts.

The problem with those old stories which made sense and made money, is that they’re very pervasive. They’re comforting. In these periods where the driver is shifting, we like to keep coming back to them. So, we are now back to monetary policy divergence, but at the margins the US Dollar is now the loser as other nations start cranking up the tightening lever. Same story, slightly different actors. (A bit like a female Doctor Who). Who’s hiking next, the RBA? Where is there not enough priced in?

This is all very nice, and will pan out a bit further in the suffusive heat of summer.

We are geared up now for Draghi to signal tapering in his August Jackson Hole speech, and maybe even hint at it at the ECB meeting on Thursday. We wonder how he will deal with the fact the Euro will rise, but we take it higher anyway.

We will ponder whether the US may ever raise rates again. Or if they do in December, is it just a sayonara shot from a departing Janet Yellen? Stories are now circulating that the man responsible for finding her replacement, Trump’s buddy Gary Cohn, might end up being her replacement himself.

Separately, stories circulate that the BOJ are concerned with their own levels of ETF purchases. The point is that QE is over. But we interpret it within our comforting monetary policy divergence story. In that story, there were currency wars as the central banks sought to outdo each other in their easing. Now, they’re seeking to outdo each other with their hiking. At some point we will realise that has much less benign implications for the economy, which will impact politics, which will impact volatility, which will impact the wisdom of the carry trade.

But for now, the shifts in monetary policy are still being seen through the comforting lens of that old story.

Let it lull you to sleep on the beach – for now.

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