Discipline Argues Against Consensus Narrative

Following the release of the FOMC minutes from last month’s meeting, the
consensus narrative that has emerged says that it was dovish because there is a
growing worry the reason inflation fell is not simply due to transitory
  This explains,
according to the narrative the dollar’s losses and the stock market

It seems reasonable until one looks closer.  The best proxy for
Fed expectations is not the dollar or the 10-year yield or stocks.  It is
the Fed funds futures and the short-end of the coupon curve.  The implied
yield on the December 2018 Fed funds futures rose one basis point
yesterday.  The two-year note yield rose half a half a basis point
yesterday.  The signal is not in the magnitude of the move but

The market has come to accept a December rate hike, just as it had to be
led by the hand to recognize the March hike. 
It has been skeptical of
hikes next year.  Consider that the effective average Fed funds rate has
been 1.16% since June’s hike.  A December hike will bring it 1.42%. 
A hike in 2018 would then lift the effective average rate to 1.67%.  The
first Fed funds futures contract that has an implied yield at that level is
March 2019.  

What of the dollar?  It had
sported a softer profile this week after reversing higher following the US jobs
data at the end of last week when in our
view, the market had nearly completely discounted a Dec rate hike, and the 10-year yield reached the upper
end of its six-month trading range.  We thought that the focus would shift
back to the ECB from the US employment data.   Perhaps, also contributing
to the pullback in US yields are the concerns about the status of tax reform.

The euro is extending its four-day advance into today’s session. 
The gains have carried it to the $1.1880, which corresponds to 50% of the drop
since reaching almost $1.21 on September 8 and bottoming last Friday near
$1.1670.  The next retracement objective is near $1.1930.  We
anticipated this euro bounce and suspected
that late longs are vulnerable to tomorrow’s US CPI and retail sales report
that will be impacted by the storm, and
the tight inventory/sales balances for some household goods.  Again, we
point out that while the September jobs report
was skewed by the storm
, the upward revision to August average hourly
earnings was not.  

The enthusiasm for Spanish assets is somewhat diminished today. 
The bonds are flat while European bonds are mostly firmer.  The stock
market is off, but holding up better than most other major European
markets.  Rajoy has taken a measured step in the face of Catalonian
officials signing a declaration of independence and then many signing a decree
suspending it.  Rajoy has given
officials until Monday morning to clarify their stance.  And if they insist
on claiming independence, they will be given another three day grace period to
reconsider before Rajoy sets into motion the process that would force the
Catalan administration out of office. Rajoy appears to have the opposition
Socialists support.  Rajoy did appear open to the Socialist proposal for a
committee to be established to discuss regional powers, but not to enable a
referendum for independence.   

Following the recent national reports from Germany, Italy, and Spain, it is not surprising that eurozone
industrial output surged in August. 
The 1.4% increase was the largest
since January, and the July series was revised to 0.3% from 0.1%.  These kind
of reports that show the eurozone economy continues to expand at a robust and
above-trend pace are a bit beside the
point ironically.  The message from the ECB’s leadership is about
disappointment with price pressures not sluggish growth.  

The issue at the upcoming ECB meeting is the tradeoff between the size of the continued asset purchases and the length
of the program.
  Also, the ECB’s
chief economist also suggests more information about the reinvesting of
maturing proceeds, which market estimates at around 15 bln euros a month next
year.  If the ECB were to cut its new purchases to 30 bln euro a month,
half of what is it’s currently buying,
the roll-over would bring the gross purchases to 45 bln euros a month.  

In addition to the euro’s streak,  there is another notable streak
underway:  Japanese stocks. 
The Nikkei rose for the eighth consecutive
session and now is at its highest level since 1996.  This advancing brings the Nikkei to a solid if not spectacular
9.6% rise for the year.   Japanese stocks have been helped by the global rally and growing
confidence that Abe and the LDP will win the snap election later this
month.  The MOF will provide new data tomorrow, but we note that in the
last week of September, the most recent data, foreign investors snapped a
nine-week streak in which they were net sellers of Japanese shares.   
Year-to-date, foreign investors have sold $17 bln of Japanese and it all took
place in Q3 and most of that (~$15.5 bln) in September.  

The best indicator of the dollar-yen exchange rate remains the 10-year US
The correlation of the percentage change of the two over the
past 60 days (0.81) appears to be the highest since at least the
mid-1980s.  After peaking at 2.40% before last weekend, the yield slipped
to 3.32% earlier today.  The dollar is trading inside yesterday’s range
against the yen, which is inside Tuesday’s range.  The 20-day moving
average is found near JPY112.30. 
The dollar has not closed below this average since September 11.  On the
other hand, it has not closed above its five-day moving average (~JPY112.55) in
a week.  

Two other short points to note.  First, Sweden’s CPI
disappointed and the market immediately took it out on the Swedish krona. 
It is the weakest of the major currencies, losing about 0.55% against both the
dollar and euro.  The market appeared to have been anticipating that a
firm inflation report would encourage the end of the super-easy monetary stance
in the face of strong growth and inflation above target.  For the record, the CPIF, which uses fixed
mortgage interest rates, rose 0.2%, half of the median expectation, for an
unchanged 2.3% year-over-year rate.   Second, the New Zealand dollar
has underperformed over the past few sessions, until today when it is the
strongest of the major currencies (0.50%)  as New Zealand First tries to
make up its mind which side to join.  Ideologically it would seem to have
more in common with the National government, but pragmatism and the desire to
share power may be more important.  

The North American session features various speeches from the World Bank
and IMF meetings,
weekly initial jobless claims, which should continue to
normalize, and September PPI.  The headline measure of producer prices is
expected to rise, but the core measure is
expected to be flat at 2.0%.  Canada reports news house price.  The
US Department of Energy reports the official measure of crude stocks.  A
third weekly drawdown is expected (~6 mln


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