Dangerous Precedent: Market Shows Fed Who’s Boss

Powell Put Solidified

It was a heck of a week for US economic data, as job gains exploded for its best figure in 11 months and new home sales surged 16% in November. The unemployment rate did rise slightly to 4%, but overall the American economy showed it was still chugging along. Yet while the US economy continues to come in with decent headlines (mostly), the Fed has gone from “a long way from neutral” to “tough to say if end of the hiking cycle”. Two opposite ends of the spectrum in just four months. Surely the economic data has not been so volatile and alarming that such jarring reactions were warranted. The Fed has preached data-dependence in their decision making, but exactly which data are they dependent on?

Most assumed that meant economic data, but it has become clear that financial markets hold as much weight, if not more, for Powell and the Fed. Global growth has slowed, but the US economy is still relatively solid and does not seem warrant such knee-jerk reactions by the central bank. The stock market overheating and subsequent correction seem to be largely driven by the Fed’s overreactions. To be fair, it may not necessarily be their monetary policy choices that have caused the mess. It is the poor choices of words and ill-advised communications that have put them at the mercy of financial markets.

As of this past Wednesday, Powell and the Fed, already signalling retreat, made their surrender to the market official. While the market was certainly expecting a dovish Fed, what they witnessed was beyond expectations. Not only did they signal a pause in the hiking cycle, they also indicated they are prepared to adjust the Quantitative Tightening (QT) if need be. They will be evaluating QT over the next few meetings, which may have bought them some time. Flipping over so quickly from extreme hawk to extreme dove has done serious damage to Powell and Co.’s ability to help the economy down the road. Now the market knows for certain the Powell Put is real, which means the next time stocks take a tumble they will be expected to once again prop up a market. This is a dangerous precedent that was once set by some of his predecessors, and we know how that turned out (see Greenspan/Bernanke Put).

Any Upside For The Dollar?

The dollar has been feeling the weight of the Fed’s about-face, and has finished six of the last seven weeks in the red. DXY staged a late comeback since Thursday and bounced off the 200 DMA, but still fell for the second week in a row. US-China talks have also played a big part in the declines, as hopes for a deal drive risk-assets higher around the world.

One of the more encouraging signs coming out of the most recent negotiations was China buying U.S. soybeans a day after trade talks. The US Chamber of Commerce also suggested China has signaled willingness to offer access to financial services, including electronic payments. While the progress on these fronts is promising, there is still nothing new to report on forced tech transfers and industrial subsidies. For this reason, its likely that some sort of deal or truce will be struck, but doubtful to be an all-encompassing one.

Retail sales at home and in Europe, FOMC chatter, ISM, and November trade data could end up being focus points in lieu of trade headlines. With the Fed completely backing down, it would likely take a serious souring of trade talks and rhetoric for the Dollar to make a significant move higher this week. A turn for the worst in the Brexit saga or other global risk headline could also be a catalyst for a stronger greenback, but if not, the upcoming week has a neutral to slightly bearish outlook for the dollar.

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