The dollar and the Fed

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A growing chorus of economists have argued that the Fed should aim for nominal GDP. Inflation of 2%, which the Fed is targeting at 2% (now on an average basis, but no term for the average has been declared) and real growth of 3%, has been an elusive but desired target. In nominal terms, the US economy grew more than 10% annualized in the first quarter, and it appears well above here in the second quarter. In fact, after the disappointing jobs report, the Atlanta Fed’s GDP tracker sees second-quarter real GDP at 11% annualized, down from 13.6% before the jobs report. The New York Fed tracker slipped to 5.1% last week from 5.3%.

Many high-income countries contracted in the first quarter, but are recovering, and positive growth is likely to move forward. The acceleration of the US economy is even faster, which means the divergence may extend a little longer. However, the real takeaway from recent news and developments is that the divergence meme comes to an end. In fact, surprise data models show the United States is weakening and Europe is improving and can only be highlighted by the nonfarm payroll report. In addition, vaccine deployment to other high-income countries is accelerating and Europe’s seven-day average has overtaken the United States. This is partly a catch-up function after a slow start. However, there is another problem unfolding. A significant minority appear reluctant to take the vaccine.

As we have understood, collective immunity does not require that everyone be vaccinated. The greater the contagion, the greater the percentage of people who should benefit from immunity. It is possible that some regions, and even some states, do not have the coverage that doctors and scientists deem necessary to obtain collective immunity. In the United States, vaccines are still considered for emergency purposes only, making it difficult for public authorities to force the release. Making vaccines not just for emergencies could facilitate the imposition of greater social ostracization on those who refuse a vaccine. While the modern libertarian spirit may be the force behind attempts to decentralize finance, the public health crisis seems to be pushing in the opposite direction.

We anticipated that the divergence meme turns into its opposite, namely convergence. However, another divergence opens and one in which the United States is lagging behind. Federal Reserve management says it is too early to even talk about adjusting the open tap of monetary policy by slowing the pace of bond purchases from the current rate of $ 120 billion per month. Canada has also started the phase-down process. Last week, the Norwegian central bank reaffirmed its intention to raise rates before the end of this year. The Bank of England has said it will slow down its weekly bond purchases and look to complete them this year.

There will be a heated debate next month at the ECB on the pace of its bond purchases. Several of the more belligerent members apparently want to slow down from the accelerated pace agreed to in March. The new staff forecasts at the meeting will likely revise their growth forecasts upwards and take into account the fallout from the large US fiscal stimulus. The Reserve Bank of Australia could also be ahead of the United States in adjusting its policy. In July, it will decide to extend its control of the yield curve to the November 2024 bond and a new bond purchase program.

With the strong budget support, pent-up demand, the vaccine, the reopening, the Fed’s position seems to stretch credulity. While April’s employment data was woefully disappointing, and the 146k downward revision of the March estimate shows that the labor market recovery is not as powerful as it seemed. Cleaning up the initial weekly jobless claims of fraudulent deposits may have exaggerated the drop in deposits, but it also overstated the increase. Initial weekly jobless claims fell below 500,000 at the end of April for the first time since March 2020. The four weeks were 866,000 at the end of January.

Unlike the downside of a business cycle, the problem may not be on the demand side of the labor market, but on the supply side. Without fully open schools and daycares, many of those who could take on new positions or return to old ones cannot. Others may still be reluctant due to the virus and the availability and confidence in public transport. Like the Chamber of Commerce, some have called for an end to the federal government’s weekly unemployment compensation supplement of $ 300 to address what anecdotal reports suggest is a labor shortage.

After the great financial crisis, it took five years for the unemployment rate to fall below 6%. It was 6.1% last month after falling to 6% in March. It has more than halved from last year’s peak. After the great financial crisis, it took six years from the peak of unemployment to be halved. The underemployment rate fell to 10.4% from 10.7% in March. In the GFC, it peaked in 2009 and was not less than 10% until the end of 2015.

April’s retail sales and industrial production reports will shed light on the significance of the disappointing employment data. Does it signal a slowdown in the US economy? Has the budget buzz dissipated, as some suggest? Strong and strong auto sales suggest a healthy retail sales report, but the employment data seems to have scared some economists who have lowered their forecasts. The record US trade deficit in March showed companies were anticipating strong consumer demand. Manufacturing employment fell 18k instead of increasing 54k as forecast by the Bloomberg survey’s median forecast, and some have downgraded their manufacturing / industrial output forecasts.

The other target is inflation. Next week, the April CPI and PPI will be released. If the price pressures turn out to be temporary, reasonable people may differ, but what seems clear is that the threat of deflation has all but disappeared. The year-over-year CPI rate stood at 2.6% in March and is expected to jump to 3.6% in April. This is partly the base effect, as last April’s drop deviates from the 12-month comparison.

The average monthly increase in the CPI in the first quarter was just over 0.4%. This increases the impact of supply chain problems and shortages. The Bloomberg survey’s median forecast was for a 0.2% increase in April. Over the past 10 years (120 months), the US CPI has increased an average of 1.7% and 2.3% over the past 30 years (360 months). The averages of similar base rates are 1.9% and 2.3%. Averages reflect the general trend of decreasing price pressures and the extent to which they follow each other over the medium to long term.

Producer prices jumped 1% in March to a rate of 4.2% year over year. The median forecast from the Bloomberg survey is that the monthly rate will slow to 0.2%, but the year-over-year rate will accelerate to 5.8%. Just over a third of the year-over-year increase comes from food and energy, which, if removed, is expected to grow to a rate of around 3.7% of year to year in April. This means that the cost of inputs, including packaging and transportation costs, increases. As a result, one of three things, or more frequently it seems, a combination takes place, costs are passed on to the consumer, narrow profit margins are accepted, perhaps to maintain market share or increase productivity.

The point is, once again, that the threat of deflation has been exorcised. The first debate is not about removing monetary stimulus. The idea is to slow down the number of new homes by reducing bond purchases. In Japan, quantitative easing through Rinban’s operations before the great financial crisis was the norm, but in the United States, the purchase of long-term assets is a matter of triage, but now the patient has had a broad fiscal and medical vaccine, and a little extra money. vitamins, and begins to function. Therapy is still needed, but triage less.

While Fed management is reluctant to signal that it may begin to consider reducing the pace of its bond purchases, the Treasury will auction $ 126 billion in coupons during the quarterly repayment next week. The primary reseller system compels the necessary purchases. However, auctions can be sloppy – low bid coverage, a large drag, an immediate drop in yield after the auction, as we experienced with the sale of the seven-year ticket earlier this year.

Given the size of the budget and current account deficits, the United States must offer a combination of higher interest rates or a lower dollar. The Federal Reserve is blocking the first and is ready to accept the second. Among high-income countries, the US 10-year banknote has performed the best in the past month. Yield fell almost 10bp, while European yields rose 10-27bp.

In addition to the 10-year signals, take a look at what happened to the December 2022 Eurodollar futures contract. The implied yield moved higher in the first quarter and peaked in early April around 53bp (cash is around 16bp). bp), nearly 35 bp more than it had started the year. The dollar generally trended higher in the first quarter. Since the beginning of April, the yield has fallen and has taken another important step after the disappointment in employment. The implied yield traded nearly 37bp before the weekend, essentially offsetting this year’s rise. The dollar followed performance lower.

Tapering is not a tightening, but the market knows it, and the Fed knows the market knows that tapering is the first step towards tightening. The Fed may not want to signal a cut because it doesn’t want the markets to work with it and tighten financial conditions prematurely. Fed officials probably appreciate, if not better than Wall Street, that there is no free lunch; there are tradeoffs. The imbalance will be corrected either by higher interest rates, or by a fall in the dollar, or by a combination.

This article was written by Marc Chandler, MarctoMarket.

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