December 15

Yellen Caught Between Jobs and Oil

The outlook for the US Dollar versus other zero yielding currencies has been unclear for the last month. EURUSD, GBPUSD and USDJPY all remain in relatively tight ranges even as we have seen a good string of data. ISM services, Retail sales and non farm payrolls are the standouts, with all coming in well above estimates. The biggest factor seems to be the pickup in wages detailed in the November employment report, along with the boost to retail sales coming from gasoline savings. Meanwhile the continued decline in oil is reeking havoc on inflation expectations globally.

The WSJ reported today that the FOMC is likely to look through the volatile moves in oil, as their impact in the long run on core inflation is not likely to warrant a significant adjustment of policy (away from mid 2015 hikes). While I agree with this view, Janet Yellen has a unique talent for recognizing both sides of the mandate and never really paying more respect to one over the other.  Fortunately for Chair Yellen she will have an hour long press conference to explain the FOMC’s stance.

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Traders will keenly be listening for references to rising wages. Last month’s payrolls report showed a 0.4% increase in average hourly earnings and the question remains whether this single report will be enough for the Fed to adjust its language. The number two man at the Fed, Stanley Fischer said on December 1st that “If the labor market continues to strengthen, and if we see some signs of inflation beginning to increase, then the natural thing is to get interest rates up”. Remember the FOMC is focused on core inflation, so they are much more likely to treat the affects of oil volatility as transitory.

There is still much focus on the ‘considerable time” language.  The last statement read that rates will not rise until a “considerable time” “following the end of asset purchases this month”. While there is much focus on the considerable time language, some FT reporters have pointed out the “this month” part must obviously be changed and could read “in October” to signal that the clock on hikes is already running. I would imagine that could even possibly be seen as putting March hikes on the table, which is extremely hawkish. NY Fed boss Dudley has stuck with his outlook for mid 2015 hikes. Bullard has been silent as equities have sold off, making no mention of adjusting policy as he did during October’s bout of risk aversion.

Without any decisive comments from Fed lieutenants recently it is difficult to make any informed guesses about what will happen on Wednesday. What is clear is that there is no need for the FOMC to be super hawkish or super dovish given that overall things are going very well. The falling oil prices are delivering a stimulus to an economy that is creating jobs at the fastest pace since the 1990s. As long as the United States remains isolated from stresses in Europe, Japan and the BRICs the FOMC will be on auto pilot towards hikes. There is currently no full hike priced in until September, which makes me feel that fixed income speculators are probably under appreciating the risk for earlier and faster hikes. If this fear becomes more of a reality expect more pain for EM and commodity currencies.

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