Keep it Real, Not Nominal

Ahead of the 3^rd Fed rate hike, the US dollar for all the world’s love for it is barely higher than it was two years ago. On March 13^th 2015 the euro heavy dollar index closed at 100.33 and today stands at 101.34. On that day in March 2015 the euro closed at $1.0496 and is near $1.07 today. This is with all the divergence in monetary policy between the Fed and the ECB. I repeat my positive and contrarian stance on the euro as I don’t subscribe to the political worries this year ahead of the key elections, the ECB is pulling back too from its extraordinary measures (will negative rates end before QE does?) and the euro region still has a trade surplus. Also of note, gold on March 13^th 2015 closed at $1152 vs $1207 today as of this writing. I seem to hear every day that higher nominal US interest rates is negative for gold but I need to remind people of what happened the last time the Fed embarked on a rate hike cycle. That started in June 2004 off the 1% fed funds level. Gold then stood a few bucks below $400. Just before the Fed got to 5.25% in the fed funds rate, gold traded above $700. See chart:

 

Bottom line, look at real rates, not nominal when trying to call the direction of the US dollar and gold. The nominal 5 yr yield is at 2.09% vs 1.59% two years ago. But, the real 5 yr yield today is at -.03%, essentially unchanged with -.003% on this same date in 2015.

The uneven recovery in Japan continues with little consistency anywhere. January machinery orders fell 3.2% m/o/m, well worse than the estimate of down .1% and December was revised sharply lower to a gain of 2.1% vs the initial print of up 6.7%. The y/o/y decline was 8.2%. Weakness from manufacturers was the main culprit.

The BoJ also meets this week and while we don’t expect much, there are signs that BoJ’s QE pace has been running below the 80T yen annualized. With ‘yield curve control’ their main focus rather than a specific absolute level of QE, we may be in the early days of a taper. I’ll say again that this year will be the first time that all four major central banks are stepping back in some form from ultra accommodative policy. We’ve seen peak global monetary easing. Expect multiple compression to be the inevitable result. The yen is higher and the Nikkei closed up a touch. JGB yields were little changed overnight with the 40 yr yield near the recent highs.

The BoE meets too this week as pressure grows on Mark Carney as he still has pedal to the monetary metal while inflation is flaring big time there with the weak pound. Inflation breakevens are off their peak but are still up dramatically since Brexit. The 5 yr inflation breakeven sits at 3.05% vs 2.30% on the day of the vote. At the least the BoE should take back the emergency easing they put in place soon after the UK vote as their worst fears never came anywhere close to happening.