The Fed notices the dollar

Well, that was an interesting set of Fed minutes, in much the same way that colon exams are interesting to their unhappy recipients.  For many market participants, Macro Man would venture to guess, the outcome was a series of intense if not not pleasant sensations.

Your author doesn't intend to engage in a thorough exegesis of the minutes, but there were a number of points which struck him.  The shot which hit the market's bow was, of course, the explicit reference to the dollar, and how it might impact both America's external accounts (X-M in GDP accounting) and, of course, the all-important 2% target for the core PCE deflator.  We can leave aside comments that the inflation target is really nonsensical- the average for the decade before the crisis was 1.75%, for example- and instead focus on why the Fed chose to raise the issue.

The Fed cited the euro, yen and sterling as weakening against the dollar.  Hmmm...let's see....the ECB had just announced an asset purchase program, speculation was mounting that the BOJ would add to its own QQE program, and the Fed meeting took place the day before the Scottish referendum, thus putting a significant risk premium on sterling.  More broadly, even in the absence of idiosyncratic factors elsewhere (the same sort of idiosyncratic factors, it need not be said, that provided a US tailwind via a weakening dollar for much of the Fed's QE adventures), does it really come as a surprise that the dollar might strengthen as the Fed starts to contemplate its first tightening in nearly a decade?  Really?

Perhaps Macro Man's reading too much into this, but it looks like one of those cases where those PhD models that assume "all else being equal" might have allowed its range of adjustable factors to be a little too narrow.  Either that or, as Yellen herself suggested, the Fed might be able to learn something from markets.   Sadly, if the recent dollar rally came as any sort of surprise, the FOMC might have to start with the basics- defining "mine", "yours", etc., because it would appear they have a LOT to learn.

Moreover, thanks to the shale revolution and the generally well-behaved consumer, it's not exactly like the US trade deficit is at all threatening.   Indeed, the current deficit is narrower in nominal dollars than it was a decade ago, and doesn't appear to be going anywhere.  (Admittedly, it's much too early for the recent dollar strength to impact the data.)  In any case, it's not like a stronger dollar is full of unalloyed negatives.   Lower commodity prices deliver a tasty positive income shock to households, which could spur a bit of  the spending that has thus far been fairly tepid in the expansion.


As for the DXY, it does look like the biggest flamingo in macro space currently.  It's easy to forget how neat the euro down-trade was; it could easily retrace back towards 1.30 while keeping the trend very much intact.


Another interesting feature of the minutes is that while they one again played the "stretched stock valuation" card, on balance the financial stability issue was pooh-poohed while the beneficent impact upon household balance sheets was pimped.  (OK, maybe not pimped, but at least mentioned.)  The Fed of course cannot say that they are targeting Spooz,  but it seems safe to assume that Yellen doesn't complain when they rip.

As for Macro Man, he still sees them in something of a no-man's land and frankly uninteresting at this juncture.  This is particularly the case given the forthcoming earnings season.


Finally, Macro Man was interested to read a couple of points which were roundly ignored by the market.  The first is that the minutes again noted that market pricing was quite a bit different from the dots (even more so now!) , ascribing this to pricing a element of a downside tail risk premium from a normal baseline.   This is probably somewhat accurate, though market pricing also likely reflects a "can Yellen actually look at herself in the mirror and hike" risk premium, given the extent to which she accentuates the negative.

What was also interesting is that several participants also suggested that current forward guidance gave the market a false sense of (dovish) security vis-a-vis the timing and magnitude of eventual rate hikes.   Just the other day, Dudley reiterated that a mid-2015 liftoff point seemed sensible...and yet EDM5 has rallied more than 10 ticks in two days!  Macro Man's favourite contract, Z5, rallied nearly 20 ticks peak-to-trough over the same period.

Yes, the minutes raised the USD and weak domestic demand elsewhere as "new" (ahem) potential negatives, and as such were correctly interpreted as dovish.  But they weren't unambiguously so- certainly not, in your author's opinion, to push Z5 from close to the bottom of its range to close to its top in two days.



Macro Man's had good success this summer playing the range in this contract, and it looks like it might be time to start contemplating another portfolio adjustment.

In the meantime, if the Fed really wants to "learn from markets" about arcane things like why hawkishly divergent monetary policy vis-a-vis the rest of the world might support the dollar, they should drop your author a line.  He's got some free time and could use a nice fat consulting contract.  And hey..it would put a dent in the unemployment gap......


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Anonymous
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October 9, 2014 at 8:01 AM ×

It was clear to some of the big boys how the minutes were going to come out. Someone sat on the 02 bid in Z5 euros buying 50k or so just over an hour before the release.

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Mr. T
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October 9, 2014 at 8:26 AM ×

insanely good post.

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Anonymous
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October 9, 2014 at 9:32 AM ×

All the volume in Dec15 eurodollars came after the minutes were released. No-one sat on the 02 bid because it was trading well below that.

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Anonymous
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October 9, 2014 at 10:17 AM ×

C Says
Clearly most central bankers would like to win the race to the bottom vis a vis currency. In winning that race they get the most by way of economic help from the rest of the world with which they trade. Unfortunately for Yellen the US has more factors heading in the right direction than many others and as such I don't think this is a race she can win. At best she can put a few zig zags in the trend. For example, look at the energy supply/demand dynamics for the US against the UK. Now imagining those were businesses where would you place your money? Maybe the market get's temporarily overweighted at any given time and needs to consolidate ,but as far as I am concerned the trend for $ is up and Yellen will have to swallow that.

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abee crombie
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October 9, 2014 at 12:29 PM ×

Great post mm. Clearly the fed has no idea about what it is doing with raising rates. Of course it is going to err on the side a caution. But like you I agree Eurodollars are a screaming sell up here. What the market is implying is that once rate hikes start it's going to take some magic to get back to 1 or 2% fed funds rate. But if they do start hiking, assuming the world doesn't collapse into a Russian Ebola European meltdown, employment is likely to be running full steam ahead then. ( something the fed seems to have forgotten is that employment LAGS ) and with say a low 5 or even a 4 handle on unemployment. I can't see the reasons the fed will have at that point 6 years into a recovery to keep rates ultra low. But then again maybe we just keep low rates forever, have low unemployment and low output like Japan. But I'll take a short in Eurodollar and bet against that.

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Anonymous
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October 9, 2014 at 1:04 PM ×

C Says
'face ripping' turning into bottom smacking go stand in the corner.

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abee crombie
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October 9, 2014 at 1:40 PM ×

European equities not buying the Yellen put, something to watch. Also Spoos were bouncing off the hammer bottom candle made last week going into the Fed Minutes, where we also saw strong buying. It will be important to see if we can hold the weekly close above that level. There was some serious liquidation in oil/MLP names yesterday AM. Also R2K was near range low but did a nice reversal.

So far so good, but we're not out of the woods just yet in equity land

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October 9, 2014 at 5:56 PM ×

My key takeways:
1. Fed is very worried about the economy and market participants reaction, especially because of 2 below
2. Absent a disaster, there will not be more policy accomodation from here (the most important of the minutes, nobody mentioned: "In their view, the costs of downside shocks to the economy would be larger than those of upside shocks because, in current circumstances, it would be less problematic to remove accommodation quickly, if doing so becomes necessary, than to add accommodation."
3. Absent more money printing, it is time for markets to adjust to the lack of $85B per month of demand of financial assets.

There is only one way to go for now, that is taking risk off the table.

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Nico G
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October 9, 2014 at 7:03 PM ×

as abee noted huge underperformance in Europe and at the risk of repeating myself we are in October 2007 again - i doubled my stoxx short today/ timeframe is a couple of months.

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Anonymous
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October 9, 2014 at 7:58 PM ×

C SAYS,
" The U.S. economy can grow at a "reasonable rate" even if the rest of the world is relatively slow, said Federal Reserve Vice Chair Stanley Fischer on Thursday. Fischer said it would of course be helpful if the rest of the world was growing rapidly, but added that the U.S. could be the single engine of the global economy."

This works a little bit like religion in that you have to suspend every neuron capable of analysis and just go with faith.
Dare I say they are starting to sound a little strident and desperate.

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abee crombie
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October 9, 2014 at 8:06 PM ×

Well NicoG, you so far have been right. My open ended question is do you sell here or wait for S&P to test 1900, the previous low and also 200day.

That is my short level. If we break there i think we see a swift move, perhaps even to January's low of 1750 before buying comes in. At that point there will probably be enough bargins to bring in some bargain hunters

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Right Field
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October 9, 2014 at 8:10 PM ×

We forgot the part where the USD was not mentioned once in the actual statement or that it was referenced maybe once in the Q&A at best. However, if it was discussed at the meeting, even if just a one liner in the secretary notes, there is scope to have it re-written by the Chair apparently. Begs the question why these are not embargoed... so now we have global growth, the US Dollar, Dots (Stein said before he left that we should never pay attention to these anyway), employment and inflation. Perhaps there will be a new index they create for each one?

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Leftback
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October 9, 2014 at 9:51 PM ×

Agree with MM on a likely retrace to 1,2900-1,3000 for EURUSD and that's how we are positioned at present, with a small garnish of JPY on the side.

Happy not to be involved in Spooz (LB is on the road), today was indeed a visit to the woodshed. Haven't bought any of these dips in SPY on the way down, but fairly convinced that there will be significant buying interest when we get to the 200dma. It is now easy to see the rotation in equities, value being bought on the up days and growth being sold on the down days. SPX 1900 seems a formality now.

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CV
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October 9, 2014 at 10:05 PM ×

Hmm,

European equities in full-on crash mode here ... which brings me to the EURUSD retracement. My own little study shows that the EURUSD downtrade has correlated VERY tightly with equity outflows. It does not look to me like there is any relief here anytime soon. If Eurozone assets are about to REALLY get taken to the cleaners ... EURUSD is toast in my view.

As for Spoos ... I have no objections to 1900, 1800 ... who knows.

Claus

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Anonymous
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October 9, 2014 at 10:19 PM ×

20 day low then 1% up day then 20 low > 200ma. Since '61 only 5 occurrences. Not consistent, but 1 was 3 days before crash of '87

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amplitudeinthehouse
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October 9, 2014 at 11:30 PM ×

The slide in indices resembles my Zazen, I've accepted that I'll never be in the zone to clearly recognize all the reasons why people buy and sell as like where my perception really comes from ,but now and again the price action induces an ineffable sense of reason why you have to trade it alone and hope traders follow.
Let's Zazen these motherfuckers!

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amplitudeinthehouse
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October 10, 2014 at 10:50 AM ×

That's about it for my positional calls for the SP500, though I would like to throw up a chart of gold, you see that red trend line?..the shorts were invisible for over ten years until it crossed that support line, I want you to know that.

http://i787.photobucket.com/albums/yy158/ActionMillward/Goldupyourass.jpg

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Nico G
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October 10, 2014 at 11:54 AM ×

abee regarding spoos

it is still remarkable that US equities are still up on the year considering how much shit 2014 has brought up - for guys who've been riding long/watching for almost 6 years now it will be impossible to detect a change in trend

not when everyone and their sisters expect buyers to come in at some point blablah they are just blind. so my point is, you either get out here and call it a year, or risk to freeze for the next 200 points

i really believe the trend has changed and 1700 is in sight and it could be damm fast once dip buyers are stopped on the way down - for a change - there aren't many shorts to support indices lower - look at Europe now, everyone has been caught long banks and 2014 has been a slaughter

if you look for the perfect exit point you might get lucky with a tactical bounce but today looks grim, you could get an ugly weekly close

dunno what your timeframe is - it is easy to say now that Ali Baba/expiry high was obvious but for months you have been warned by credit - credit traders are not distracted by Cramer and the like

it is late 2007 again when credit compression peaked before summer and it took a few months for equities to catch down

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Leftback
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October 10, 2014 at 12:58 PM ×

Generally agree with Nico there is no value in Spooz at all at these levels. Not sure that this is the apocalypse but not going to be dipping any toes in this one.

However, looking around the investing world... EU peripheral bonds not horrible, the European oil and energy sector hammered and offering decent yield here. EDP, ÖMV, RDS, TOT etc.. that looks like it might turn around soon. I do want to see EURUSD catch a bid for many reasons.

Over in the US we aren't seeing any movement at all in mREITs, when a safe haven actually performs as intended it's a) a huge relief and b) usually a sign that everyone isn't experiencing a liquidity crisis, not to mention c) an indication that those higher rates might be a little further off in the future than some titans had proposed (cough: David Tepper).

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Leftback
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October 10, 2014 at 1:02 PM ×

This might be the day that we see the US30y below 3.00%. Treasury shorts can be expected to come under considerable pressure this morning.... :-)

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Anonymous
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October 10, 2014 at 2:08 PM ×

Bet Tepper feels stupid of late with his 'bonds a bubble / stox cheap' about 3-4 weeks ago

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Anonymous
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October 10, 2014 at 2:16 PM ×

Low bear count...

http://imgur.com/uXrEJ0b

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Anonymous
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October 10, 2014 at 2:19 PM ×

C says
Anon 2.08,
It doesn't matter who your name is ,because you'll still be lucky to call it right better than a flip toss. I have yet to meet anyone who qualifies on that score ,but some do do a lot better when it comes to achieving a return within a stated range. And I would still like to have made a much money has Tepper who if he were to feel stupid need do no more than look at his personal worth and smirk!

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Anonymous
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October 10, 2014 at 2:20 PM ×

Steen Jakobsen's growth & yield forecast chart...

http://imgur.com/NnWlrwn

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Anonymous
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October 10, 2014 at 3:24 PM ×

soooooooany....anyone legging into energy names yet?

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Anonymous
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October 10, 2014 at 3:55 PM ×


If anyone care to check out these charts..Prescient calls on $gold and $wtic by Jamie Saettele,CMT.I have followed this guy since last year and he bascially nailed the gold top!
http://www.dailyfx.com/forex/technical/elliott_wave/oil/2014/10/09/eliottWaves_oil.html

http://www.dailyfx.com/forex/technical/elliott_wave/oil/2014/09/02/eliottWaves_oil.html

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Anonymous
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October 10, 2014 at 5:01 PM ×

Needless to say, if you plan to buy energy names , be sure you look at debt levels . that's what's really killing some names vs just oil prices

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abee crombie
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October 10, 2014 at 5:20 PM ×

another morining of liquidation in MLP/oil names. Now bouncing pretty well

T Boone Pickens on CNBC thinks Saudi Arabia is trying to “teach the US frackers a lesson” by allowing oil prices to drop. Pickens thinks SA wants to see US E&Ps dial back output and capex and won’t step in to provide relief until that occurs (he feels that $80 could cause those cutbacks to occur).

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Anonymous
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October 10, 2014 at 6:01 PM ×

Conspiracy theory never dies!

Many people are certain that Saudi Arabia is doing U.S.'s bidding to punish Russia and drive it to the ground.

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Anonymous
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October 10, 2014 at 6:09 PM ×

Shale boom:

http://www.bloomberg.com/news/2014-10-09/ceos-tout-reserves-of-oil-gas-revealed-to-be-less-to-sec.html

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Anonymous
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October 10, 2014 at 7:17 PM ×

The offshore sector might be in a trough but it doesn't nearly mean it will wither away and die like everyone seems to think at the moment. These are long term contracts which won't be affected unless the oil price stays low - for good.

Take a look at PACD. The best play purely towards ultradeep/deep water oil (which one wants to be in within the sector as most new discoveries are made there), making over 25% operating cash flow of market cap and with a good chance even more next year as a couple of more UDW ships come online. A baby thrown out with the bath water.

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