Thursday, March 26, 2015
Chief Economist Query; Fed Gets Dollar Wish; Treasuries (oil) Respond (chart)
With respect to my earlier note, a well recognized Chief Economist at a Chicago Based financial services firm offers the following:
Query: Isn't it the uncertainty surrounding the us economy and uncertainty surrounding oil that are affecting the dollar more than the Fed.
This seems a bit of putting the cart before the horse. The Fed was concerned about the dollar's dampening effect on U.S. economy.
Response: Thank You. You raise an interesting point. I was taken by the extent Chair Yellen referenced the dollar in the March FOMC post-meeting press conference. Within the first paragraphs of her address, she noted its appreciation in the context of inflation; ‘Declining import prices have also restrained inflation and, in light of the recent appreciation of the dollar, will likely continue to do so in the months ahead.’ And shortly thereafter the dollar in noted with respect to growth; ‘For economic growth, participants generally reduced their projections since December, with many citing a weaker outlook for net exports.’
Clearly the currency values have an impact on domestic activities and it is normal for the Fed to speak to these conditions and factor them in when addressing monetary policy. Even so, there was something in the way Chair Yellen responded to this issue, both in her initial address and the response to questions that heightened my sense that she (the Fed) might have a bit of an agenda.
The first question Yellen fielded was from Howard Schneider with the Reuters where he noted to this point there had ‘been this pretty consistent reference to expectations of above-trend growth’ and now ‘growth downgraded in the context of very explicit references to international and external conditions, weak export growth, oil dragging down inflation, and your own comments now on the dollar.’ Yellen responds; You mentioned the dollar. We noted that export growth has weakened, probably the strong dollar is one reason for that. On the other hand, the strength of the dollar also in part reflects the strength of the US economy. The strength of the dollar is also one factor that is --as I noted is holding down import prices and at least on a transitory basis at this point pushing inflation down. So we are taking account of international developments, including prospects for growth in our trade partners in making the forecast we have here.’
The point I was trying to make in this morning’s note was that ‘if’ there was some agenda at the Fed to influence the dollar prospects, arguably well beyond their ‘domain’, they have accomplished, for the moment a condition which is more conducive to the initiation of policy ‘normalization’…and thus bearish for Treasury and Eurodollar Futures.
Certainly it is the underlying conditions you note, ‘uncertainty surrounding the us economy’ that is a primary driver of the dollar exchange rate. Were market participants less overwhelming bullish on the dollar, there may have been a less dramatic dollar weakness following the FOMC meeting. If economic reports such as the durable goods report the other day not been so soft, the dollar may have remained more elevated.
Weaker domestic growth had been evident for months while the dollar continued to advance and so we might expect that a disproportional influence on the dollar strength was related to the prospects for the Fed raising rates. The reduction in the ‘dot plot’, partly the result of retiring outliers, may have forced exchange traders to concentrate more on growth than the Fed prospects.
The Fed is not comfortable in the valley between an easy monetary policy and a more restrictive one and neither are economic agents. Although the Fed has strongly advised that the forthcoming removal of accommodation will not resemble the highly visible policy rate path of 2004-2006, economic agents will have a better sense of protracted policy intent once the Fed begins raising its policy rate. Until such time, the uncertainty associated with the Fed’s plans will have a strong influence on asset prices and tend to heighten volatility in markets.