Going into today’s likely rate hike there’s been a great deal of chatter throughout the investment community regarding the risk that the U.S. Dollar Index (DXY) actually peaks “on the news” and subsequently trends lower in the ensuing months.
We even took to discussing that risk in the second half of our 12/3 note titled, “Draghi Disappoints… Is This the Beginning of the “Great Unwind” of Consensus USD Longs?”; we strongly believe that analysis is worth your time to review. The following charts are arguably the two most noteworthy examples of the many Bayesian and Frequentist overlays we applied to our handicapping of the aforementioned market risk.
All factors considered, we do think it’s important to revisit why we got here. We’ve held intermediate-to-long-term bearish biases on the Japanese yen since 4Q12 and, except for a brief respite throughout 1H14, a similarly bearish TREND and TAIL outlook for the EUR since 1Q13. With the JPY down -32% over the past 3Y and the EUR down -19% over the past 18M, we would argue those have been good calls.
Kudos aside, our proprietary GIP Modeling process and quantitative risk management overlay leads us to conclude that it is appropriate to maintain our intermediate-to-long-term bearish biases on the EUR and JPY. Additionally, recent developments out of the PBoC and BoE support adopting similar biases on the CNY and GBP as well.
As such, it’s no surprise to see the DXY remain bullish from an intermediate-term TREND and long-term TAIL perspective on our quant factors.
Eurozone: The preponderance of Eurozone high-frequency growth data is confirming our extremely dour NTM outlook for Eurozone economic growth. Moreover, inflation remains well below the ECB’s +2% target from the perspective of reported data, 2016 economist expectations and long-term breakeven rates. Both Draghi and ECB Chief Economist Praet were out Monday reiterating a willingness to do more if needed. If our forecasts are proven correct, they will indeed find themselves doing a lot “more” at some point in 1H16.
Japan: The preponderance of Japanese high-frequency growth data is confirming our dour near-term outlook for Japanese economic growth. While core inflation readings have been elevated relative to historic trends, they fall well shy of the BoJ’s +2% target. Moreover, we are picking up on chatter that falling inflation expectations per the 4Q Tankan Survey and long-term breakeven rates are giving BoJ board members cause for concern. While it’s unlikely they expand QQE coming out of their meeting tomorrow, we do think the timing of that catalyst has edged forward by a month or two. Specifically, we think BoJ monetary policy is most likely to get incrementally dovish at the APR 28th meeting in conjunction with a downward revision to their economic projections.
China: We’ve been pretty vocal about our outlook for a material, but managed depreciation of the CNY in recent weeks, most recently in our 12/11 note titled, “Our #EmergingOutflows Theme Accelerates Into “Liftoff””. We consider our 11/19 note titled, “Can Beijing Maintain Exchange Rate Stability Or Is the Chinese Yuan the Next Thai Baht?” to be required reading on that front as well. Key developments on that front include the PBoC’s explicit confirmation of both our structurally bearish outlook for the Chinese economy (phony accounting aside), as well as our view that Beijing intends to ensure the devaluation of the yuan will be as orderly as possible going forward.
United Kingdom: Our interpretation of the state of and outlook for the U.K. economy is remarkably similar to that of the Eurozone (not surprising given the positive slope of GDP base effects in both economies) – with the noteworthy exception that long-term breakeven rates in the U.K. remain elevated from the perspective of the BoE’s +2% inflation target. Though said rates have tightened by a fair amount in recent months, the real boogeymen lending pause to Carney are historically depressed rates of both core CPI and PPI, as well as a dovish outlook for 2016 CPI among economists. We thought Carney’s commentary from this morning regarding conditions for a rate hike as being “unfulfilled” were quite telling in the context of the GBP/USD cross’ recent breakdown below its now TREND line of resistance at 1.54. The pound should continue to follow short-term GBP/USD swap spreads lower as U.K. growth data forces the BoE to back away from its hawkish guidance, at the margins.
United States: Our view on the outlook for U.S. monetary policy begins and ends with the politicization of the Federal Reserve – which remains out to lunch from the perspective of its economic forecasts and associated “dot plot”. As we penned in a detailed note yesterday titled, “Quantifying Why the Fed Is Wrong On Its Outlook For Inflation”, we think the Fed is conflating what we view as a short-lived trough in reported inflation with a sustainable bottom in structural inflation trends. As a result, there exists considerable risk that the Fed tightens policy and maintains an unwarranted tightening bias until it is too late (i.e. we still think a recession commences in/around mid-2016). By then it could be too late for Janet & Co. to react appropriately dovish in terms of handicapping the risk that the U.S. election cycle is decidedly anti Big Fed.
Recall that our then-described “G3 policy divergence” theme has been the primary driver of our #StrongDollar #GlobalDeflation view – which itself is at the core of our long-held bearish biases on commodities (since AUG ’14), emerging markets (since APR ’13) and high-yield credit (since AUG ’14).
As such, with a TREND and TAIL bullish outlook on for the USD vis-à-vis peer currencies and the CRB Index hitting lows not seen since 2002 today, we find it appropriate to reiterate that theme, as well as key spillover effects – namely corporate profit and industrial recession globally.
All told, we remain firmly in the #StrongDollar, #GlobalDeflation camp – largely because we think the ECB, BoJ, PBoC and now BoE are all likely to remain more dovish than the Fed, at the margins – but are well aware of the aforementioned Bayesian and Frequentist risks to overstaying our welcome.
Our deep understanding of such risks leaves us in a good place to quickly make any eventual pivot to the #GlobalStagflation camp to the extent a macro market regime change is confirmed by our myriad of quantitative signals. That scenario remains the least probable within the band of probable outcomes, however.
Ex-Healthcare, which we are now decidedly bearish on as a firm, long live the #Quad4, #LateCycle playbook!
Best of luck out there,