We want specifics from Yellen but the probability of getting any is practically zero. Everyone will be seeking the barest of whispers of a hint that March might be a real possibility or that the market is wrong to say two when the Fed is saying three. At a guess, Yellen will be even more restrained and cautious than usual, if that’s possible, because this time she faces the Senate in Republican control for the first time.
Often the questions from the floor are really stupid. One Congressman asked Bernnake whether he knew anything about the Great Depression. Years ago, Greenspan told a Senator that if the Senator had understood him, he must have misspoken. We won’t get that lucky this time. The Senate committee may be downright hostile. It won’t rattle the unflappable Yellen, but the likely pending assault on the Fed’s independence is likely to start right now, today. Kentucky Senator Paul is not on this committee this time but has been poisoning the atmosphere about the Fed even more often of late. Paul’s twisted view of the Fed (and the US economy) can give you a massive headache.
An attack on the Fed’s independence is a dollar-negative. Fixed income and FX traders count on the Fed to conduct its business without any partisan political bias at all. Even when traders disagree with the Fed’s decisions, they respect the institution and acknowledge it acts out of the purest of motives. Ending that would put us back 45 years to the days of Arthur Burns, when the Fed talked incessantly about the dollar. This was before Nixon depegged from gold and floated the dollar, killing the Bretton Woods accord. Former Fed board member Sherman Maisel wrote a book in 1973, Managing the Dollar, that would knock your socks off. The mere idea of returning to the days of the Fed considering the dollar and from political motives is more than chilling—it’s paralyzing.
The prospect of a revised Fed is not remote. Trump will not renew the Yellen and Fischer contracts come January. And Fed Gov Tarullo is stepping down in early April, adding to two existing empty seats and leaving three of seven seats for Trump to fill. Trump has proven he can name wildly unqualified and inappropriate candidates, like the education secretary who hates public schools, the EPA chief who likes to sue the EPA and the veterans affairs chief who never served. We are almost certainly going to be appalled at Trump’s choices for the Fed.
We get PPI today, likely up 0.3% m/m in Jan and 1.5% y/y. The more important metric is CPI tomorrow, another potential dollar-negative. Bloomberg projects CPI at a whopping 2.4% (from below 0.5% percent in Sept 2015). The last import price index came at 3.76% when it was forecast far lower. Then there’s the prospect of a deliberate Trump currency war policy that is far more aggressive than we have been contemplating up to now (consisting of border adjustments and rhetoric). Trump may have something in mind that tears down the current framework of the FX market without necessarily having a clear idea of what to replace it with. The first shot in the currency war is a WSJ op-ed by Judy Shelton, headlined “Currency Manipulation Is a Real Problem. What’s the point of free-trade deals if governments can wipe out the benefits with monetary maneuvers?”
Shelton says of course Japan and China were manipulating their exchange rates. Trump will take steps to put rules in place to stop it. “The next step is to establish a universal set of rules based on monetary sovereignty and discipline that would allow nations to voluntarily participate in a trade agreement that did not permit them to undermine true competition by manipulating exchange rates. “Mr. Trump’s penchant for identifying core problems and taking bold actions to resolve them is encouraging. He would do well to take the next step for the sake of free trade and to establish a system that ensures stable exchange rates.”
How, exactly? Shelton doesn’t offer an outline, but most likely the US will design a giant spreadsheet that shows an undervalued currency as having received a government subsidy. Analytically, this is probably defensible, but in practice, having a US company victimized by foreign competitors sue for redress on the grounds of currency manipulation is a can of snakes. Who will be the judge? As we have seen repeatedly at the WTO, these cases are hard to make, harder to win and take forever—so long, the plaintiff can be out of business before it wins.
So far nobody much believes Trump can bomb the current system out of existence. FX is the freest of free markets, the very pinnacle of “high finance” and tremendously efficient. It would take severe capital controls to squash it, and even then, markets have a way of just moving somewhere else when controls are imposed. But we mustn’t forget the Announcement Effect. You don’t actually have to change the rules. You just have to trumpet that you want to, or will.
Bloomberg thinks big global investors already see it coming and features an article on US creditors dumping Treasuries—even before we get the TICS report tomorrow. “In the age of Trump, America’s biggest foreign creditors are suddenly having second thoughts about financing the U.S. government.” That way of phrasing it is striking. Japanese investors have cut holding of US paper by the most since 2013, while hedged returns arte the worst on record.
“From Tokyo to Beijing and London, the consensus is clear: few overseas investors want to step into the $13.9 trillion U.S. Treasury market right now. Whether it’s the prospect of bigger deficits and more inflation under President Donald Trump or higher interest rates from the Federal Reserve, the world’s safest debt market seems less of a sure thing -- particularly after the upswing in yields since November. And then there is Trump’s penchant for saber rattling, which has made staying home that much easier. “… Nobody is saying that foreigners will abandon Treasuries altogether. After all, they still hold $5.94 trillion, or roughly 43 percent of the U.S. government debt market. (Though that’s down from 56 percent in 2008.) A significant drawdown can harm major holders like Japan and China as much as it does the U.S.”
A separate op-ed in Bloomberg has it that the “World's Biggest Debt Market Faces Huge Test From Trump.” Promoting exports over all else and favoring import substitution is “like encouraging people to cook by banning restaurants.” We don’t quite get the metaphor but it sounds terrific.
US government debt is actually our biggest export. “And yet U.S. Treasuries have been finding far fewer foreign buyers in recent months -- a trend that has so far been offset by higher domestic demand. U.S. investors have been buying longer-term government debt at a record pace since June, while recent data shows Japanese buyers, the biggest owners of U.S. Treasuries, have reduced their holdings for two consecutive months.”
“Adversaries of import substitution have long argued that the strategy boosts short-term growth at the expense of longer-term health. It flies in the face of comparative advantage -- a central tenet of classical economic theory -- and precludes economies from enjoying all of the benefits that come with specialization, including lower prices. A similar dynamic applies to the transformation of the U.S. Treasury market. While a pickup in domestic demand can initially help offset selling by foreign investors -- such as the People’s Bank of China attempting to stabilize the yuan or Saudi Arabia reducing reserves to deal with lower oil prices -- it may well leave the market more fragile over the longer term.”
“Perhaps more relevant to Trump’s ambitions are the self-apparent limits that a domestically funded budget will put on his growth plans. The president wants to boost fiscal stimulus while cutting taxes -- a plan that will only work as long as the U.S. is able to issue and sell its debt. Few think that foreigners will stop purchasing U.S. debt altogether, but the loss of a significant pool of players will by definition place a cap on the market.”
One thing we can derive from the Bloomberg articles is that the editorial team is deeply, seriously worried about Trump not just upsetting the apple cart, but burning down the orchard. The FT has a similar bias and sometimes the WSJ. We expect this kind of thing from the “liberal” press, but doom-andgloom from the top financial outlets is as good a sign as any that complacency (on equities hitting records, for example) is a bad idea.
Tidbit: The Daily Shot reproduces an interesting table from NATO showing defense spending as percentage of GDP. We all knew the US would be the top name, but didn’t know defense spending was so low in most of Europe (Germany, 1.19% vs. the US, 3.61%). Various politicos have complained over the years about other countries not pulling their weight. Trump will be the one who does something about it. He may not do it well, but it’s on the list of campaign promises. Obviously it will run smack into Treaty promises of limits on deficit spending.
By Barbara Rockefeller
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