The divergence between surveys and hard data in the US continued yesterday. The Conference board’s index of consumer confidence increase to 121.1 in July assent expectations for marginal decline. When you compare this to the negative trend in retail sales investors, have a distorted perspective of the US economy. We take a way two key points in this situation, first is that the real economy is underperforming expectations and second that the Fed threshold of reducing their blotted balance sheet is significantly lower than increasing interest rates.
Weak USD was built on the expectations of no hikes in 2017 but seems to sidestep the potentially more destabilizing effect of exit on global yields. Yield spread differentials between US and G10 nations have narrow while VIX index has fallen to new historical lows. Reads suggest that there is limited risk with the Feds current policy path. Markets are uniquely focused on inflation to their detriment, as in our perspective the Fed will continue to tighten via balance sheet reduction regardless of inflations levels.
For today’s FOMC meeting we don’t see any real market impact. We anticipated slight adjustment in languages highlight the transitory weakness inflation and stronger labor markets. More importantly we don’t expect any additional clarity on the fed exit strategy which will likely come in September. USD has become increasingly sensitive to interest rates and with limited expectations for repricing Feds interest rate path, today a reversal in USD is unlikely. Yet additional USD weakness is unlikely do to overstretch short position unless the Fed becoming meaningfully dovish.
By Peter Rosenstreich