I updated my US leading indicator yesterday (now that all of the February data are in) and it continues to point resolutely upward. The US economy is doing very well. There will be a whole host of reasons for this, but I have seen a couple of interesting ones this morning. First, Barclays has pointed out that the very low price of natural gas (thanks to shale gas extraction) will be helping to offset the depressive effect of high oil prices. Second, the Fed’s actions have meant that household financial obligations as a percentage of disposable income have fallen to a 28-year low of 16% (down from a peak of 18.75% before the crisis; http://bit.ly/HjsDLv) — which will be a great help to households in the deleveraging process.
US Interest Rates
I said last week that, in order to complete the picture on the Japanese yen, I needed to consider whether US 2-year interest rates were likely to rise. I think that the answer is that they are not. The movement of 2-year rates is closely linked to monetary policy. The Fed has recently said that it expects rates to remain low until late 2014. This is not quite a commitment, but it is clearly meant to convey the idea that the FOMC does not have its finger on the trigger, ready to tighten policy as soon as there is any sign of economic strength. Ben Bernanke has recently hinted that he would be comfortable with inflation a little above target in order to bring down the unemployment rate, and in any case inflation is low and falling at present. Against this backdrop, I think that the economy would have to get quite a lot stronger before it would make sense for the market to price in any significant increase in the probability of a rise in short-term rates into the 2-year Treasury.
Incidentally, it appears that the Fed may, perhaps more by luck than judgement, have hit on a politically-acceptable formula for keeping rates low even as economic expectations improve. I never tire of pointing out that, contrary to the implausible (model-based) analyses of economists that argue that QE has lowered bond yields, QE actually raised bond yields by improving economic expectations; with its 2014 language and affirmation of the duality of its mandate (i.e. the equal importance of inflation and unemployment) I think that the Fed may have hit on a form of loosening that is better than QE, because it keeps bond yields low even as future prospects improve.
On 5th March, I said: “[RBA governor] Glenn Stevens has, for the first time, suggested that the AUD is stronger than might be warranted by commodity prices. He actually called its recent strength ‘a bit odd’. I wonder whether this is a signficiant change the might herald a reversal of policy. As recently as November, Stevens was welcoming a strong AUD as a means of controlling inflation.” I have been much too slow with the Australian story — with hindsight, I would have made money shorting AUD there and then. In my defence, it was not clear at the start of March that AUD had decoupled from global risk, and I had not worked out the dichotomy between risk-on (driven by rising expectations for QE3) and risk-decoupling (driven by falling expectations for QE3 as a result of improvement in the US economy).
Today the RBA held interest rates. Stevens said that the pace of output was slower than previously estimated, but that the committee thought it prudent to wait for forthcoming data on prices before considering whether to ease policy. I am wary of shorting AUD now, because it has already fallen on easing expectations. But if it rallies against USD then there would be a good argument for a short.
- China non-manufacturing PMI 58. A big increase.
- Australia retail sales 0.2% a.e. Feb.
- UK construction PMI 56.7 b.e.
- Factory orders
- FOMC minutes
- Australia trade balance
- UK services PMI
- Eurozone retail sales