As QE trades continue to unwind will it really be the data that turns the Fed's hand on rates?
We're seeing another day with a full on shifting in long held positions as bond yields take off here and in the US, and European and US equities dive. The euro and pound have made large gains and the dollar has been beaten back almost everywhere
In its simplest form it's all the result of the end of QE in the US and the possibility of rates going up. We've been seeing this shift and unwinding of positions for the last few weeks and as with such trades they usually come in waves. The majors are going through the same thing that emerging markets did over the taper.
US Treasury yields were up between 2-3% today and European yields even more. European stocks are seeing heavy losses in nearly all bar Italy and the US has opened into a hole
There's also a fight going on in the mind of the market. The Fed is still looking to raise rates while the data is saying "not so fast". The slowdown has been written off as temporary (again) by most of the market but we at ForexLive have been watching things deteriorate for months
I'm one of the biggest dollar bulls and have opined that the Fed have wanted rates up for a while and will do whatever it takes to do that. They just don't want to keep rates lower than they want to for too long, just like Bernanke's "unlimited QE" was never actually meant to be unlimited. That may still be the case but now they've switched to watching the data that has started to put some cracks in my thoughts
Outside of inflationary figures, the main areas I've been watching are manufacturing/business activity and consumer, government and investment activity, and it's not been going the way it should
Of course it's a mere snapshot of the full economy but I like to use these data points to get a basic grasp of the economic picture, and it's pretty easy to see which way the trend in most of these indicators is going. Manufacturing is falling back, business activity is falling back, the consumer isn't spending, investment isn't being made, the government isn't spending. Not a lot here to say there's a bright outlook for the immediate future. There are fleeting signs though. Inflation is holding up, wages are starting to rise, consumption hasn't completely dropped off the cliff. They're small signs but they're just small building blocks and we're still at the foundation level
And therein lies the fight. In my view the data is deteriorating and has been for months. On the flipside it's still mainly in a positive/expansion range so we're not looking at anything like a recession scenario right now. We're at the point where we need to see the economy stabilise, at the very least, at these levels. If we don't then the Fed is going to find it very tough to raise rates.
My prior bias for the Fed has made me trade from the long side of the dollar but as with all strategies you shouldn't marry them. Use them for the good times and put them on the back burner if something better comes along.
I'm feeling that this is the case with the Fed and interest rates at the moment. A month or so ago I turned short term bearish on the dollar and particularly USDJPY. At the moment I see no reason to change that view, based on the data. In this pair the market isn't budging. Good data or bad, flows, whatever, it isn't moving. At the moment the market is balanced. If we do continue to see the monthly data falter further then we will see a bigger reaction.
Longer term, I still see rates going up, and if the economy even stays at this level for any length of time, that will be enough for the Fed to move. Anything less than what we have today and that makes lift off a very difficult choice
So let battle commence and may the best trade succeed. Who will win, the Fed and a better economy or bad data?