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Daily Commentary 24/03/15

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• Fed view on the dollar not affecting their view on rates We’ve heard a lot of Fed officials commenting on the dollar and its impact on their outlook. From my point of view, the market seems to be misinterpreting their statements in order to justify profit-taking. Take Cleveland Fed President Loretta Mester’s comments yesterday, for example. Her views on the dollar were similar to those that Chicago Fed President Evans and Atlanta Fed President Lockhart expressed on Friday. She said that the level of the dollar is one of the conditions Fed officials look at and that a strong dollar will affect US exports. The market focused on these comments and ignored her other comments: that it is appropriate for the Fed to raise rates this year and that a June rate hike is possible. San Francisco Fed President Williams, a voting FOMC member, said that “by mid-year it will be the time to have a discussion about starting to raise rates,” and that the dollar’s strength isn’t an impediment.

• If you don’t believe him, Fed Vice Chair Stanley Fischer said that a rate hike “likely will be warranted before the end of the year,” with the exact date depending on the data (as they’ve made very clear already). Fisher did not comment explicitly on the dollar, but did say that he thought other countries weren’t manipulating exchange rates – in other words, he’s OK with a rise in the dollar caused by other countries’ loose monetary policies. The impression I get from all these comments is that yes, the dollar may restrain exports. But that was already factored into their forecast for slightly slower growth and will not put them off raising rates. Almost all the comments I’ve heard from Fed officials still imply that they’re considering a rate hike by mid-year. I believe the market is over-emphasizing the likely impact of the stronger dollar and drawing the wrong conclusion with regards to policy. I expect a reversal of this approach at some point and the resumption of the dollar rally.

• Merkel offers tea & sympathy but no money Greek PM Tsipras met with German Chancellor Merkel and had what appeared to be pleasant talks, but there was no change in Greece’s financial position as a result. Merkel insisted that Greece had to talk to the Troika, not her. “Reforms have to be discussed with the institutions, not with Germany,” she emphasized. A Greek government official said that the country may submit a list of reforms by the end of this week. The German newspaper Frankfurter Allgemeine Zeitung reported that the Greek government has until April 8th before it runs out of money. That’s consistent with what some Greek officials have been saying. Meanwhile, the Greek economy is collapsing; industrial production (the turnover index in industry) plunged 16.0% yoy by value in January, a sharp acceleration from –7.7% yoy in December. Greece remains a major risk for the euro.

• Today’s highlights: Today is PMI day. The graph shows the general trend of the global PMIs, with the level of the PMI on the X axis and the change over the last three months on the Y axis. The best place to be is in the upper right-hand corner, which shows an accelerating expansion (PMI over 50 and rising). The second quadrant, the upper left-hand corner, shows the PMI is below 50, meaning activity is contracting, but the PMI is still higher than three months ago, so at least things are improving. The lower right-hand corner is also mixed; there, the PMI is above 50, but the pace of expansion is slowing. And the place you really don’t want to be is the third quadrant, the lower left-hand corner, where your PMI is below the 50 line and also it’s contracting – that’s where you have an accelerating contraction.

• China and Japan were first, as usual. China’s HSBC/Markit PMI was down sharply and is now back in contractionary territory. Both the Chinese PMIs are in the dreaded third quadrant (accelerating contraction). This confirms the slowdown in Chinese growth that began to appear in the data during January and February. AUD is the currency most vulnerable to slowing Chinese growth and I would expected AUDNZD to resume its slow grind towards parity. The Japanese manufacturing PMI, which attracts little attention, is now just barely in expansionary territory.

• The preliminary manufacturing and service-sector PMI data for March from several European countries and the Eurozone as a whole are coming out today. It’s noticeable that the Eurozone is in the favorable upper right-hand quadrant. It’s likely that we could see further improvement in the Eurozone PMIs this time too. However, that doesn’t seem to do much for the currency, which is dominated more by QE than by signs of economic recovery. The US Markit manufacturing PMI is expected to slow, but remain well in expansionary territory.

• Note how well Sweden is doing. It’s far in the upper right-hand corner. That’s one reason I was surprised that they cut interest rates. Probably they’re more concerned about being in deflation than about economic activity. However, their main export market is the Eurozone, which takes 60% of their exports. As the ECB’s QE program kicks in and consumer confidence comes back in the Eurozone, as we saw yesterday, their exports ought to do well. I’m bullish on the SEK, at least relative to the euro or NOK.

• On the other hand, Australia and Canada are in the lower left-hand quadrant, the worst place to be. These economies are suffering from the fall in commodity prices, particularly iron ore and oil. I expect their currencies to weaken as the terms of trade turn against them, their economies suffer, and their central banks have to cut rates to keep things going.

• From the UK, we get the CPI for February. It’s expected to fall to +0.1% yoy, just above deflation. The Bank of England’s February inflation report warned that the CPI may drop below zero. On top of that, the minutes of the latest BoE meeting showed that the members seemed more concerned than previously about inflation as it may remain below the target for longer. UK inflation is far below the BoE’s target and to make matters worse, inflation expectations are coming down too. A further decline in inflation could be negative for the pound.

• In the US, the headline CPI rate for February is expected to remain in deflation on a yoy basis, but the core CPI rate is expected to accelerate slightly. This suggest that the low energy prices are the main reason behind the deflationary pressure. The Fed has said that this is just a transitory effect, and so it’s willing to look past it. We’ll have to see how long that view lasts, particularly if oil continues to decline.

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