It was fun while it lasted. For a few brief months, The Fed appeared to 'hawkish, no matter what' as data-dependent morphed into data-ignorant. Markets relished the confidence-inpiring message from the ivory tower academics… but, as former FX trader Rich Breslow notes, none of that occurred in reality and now, "no one really believes even their own forecasts," adding that, as markets wake up to this reality, "it's going to be a long summer."
It’s hard to keep a good conspiracy theory in play if you don’t make sure all the main actors are following the story line. Clearly, the two principal Fed speakers this week, Governor Brainard and Chair Yellen decided the game had gone on long enough. Or, more probably, opted for a pause to assess how the latest experiment in message manipulation had gone.
It was interesting, indeed encouraging, to believe that central bankers around the globe saw enough distance between current economic conditions and the financial crisis to orchestrate a move toward higher rates.
But they seem to cling to the notion that they must do so without any knock-on effects to the broader category of assets. They do so love the calming sounds from the trickle-down effect.
So what have we really learned beyond the fact that no one really believes even their own forecasts?
The Canadians are team players willing to take a hit for the greater good. That everyone would indeed like to see rates rise but only at no cost. Expect, therefore, a swift return to good cop, bad cop for steering expectations. The Bank of England is already reprising that role. But the most immediately useful issue to consider is whether this dissembling puts paid to the newfound and seemingly universal love affair for the euro.
The rally in the euro didn’t really kick off when the numbers started to come in stronger. Modern theory maintains that economic results are irrelevant until officially and publicly designated as data dependent worthy. Rather, things got motoring when the ECB hinted at the notion of tapering their quantitative easing. And it did so with a vengeance. At least in analyst forecasts. What a great example of half empty becoming half full in a trice, fully vindicating the notion of animal spirits.
Therefore, either the euro is going to look even better compared to a more hesitant Fed or it’s come too far, too fast and presents a wonderful opportunity to play for the mean reversion. And the Fed does matter more broadly because euro doesn’t zoom against the dollar without making major headway against most other currencies in sympathy.
We have to consider one other point. It’s going to be a long summer. Central banks don’t want to, nor need to, put it on the line again until September and are loath to box themselves in. It’s important to make the distinction between enjoying the luxury of time versus a crisis of confidence. But that doesn’t help right now for settling on the next trade.
Which brings us to the upcoming ECB meeting. Are they going to announce tapering? Probably not, beyond acknowledging the fact that the balance of risks has improved. So that would be euro negative. On the other hand, we just got word that President Draghi will be addressing the Jackson Hole Conference in August. Definitely a euro positive. Keep ’em guessing is more in their comfort zone than speak plainly and look straight into the camera.
It’s not surprising given the cracks in the story line that the euro has retreated back to levels it broke higher from against a slew of other currencies. Fell back but hasn’t broken. Retesting break-outs and holding can be a powerful signal.
For some clues as to where we go from here watch what EUR/GBP does with the .88 level, how EUR/CHF fares here at 1.10 and, of course, 1.1350 against the dollar. It will probably sink or swim against all three in tandem.