It's nice to be back at the Factory. As I see it, the markets and US economy are at a critical point so I thought i'd weigh in with a few ideas that will include some trading opinions. Please feel free to weigh in with a few of your own. I'm going to focus on equity markets at first and the reason will become apparent later on as I apply it to a currency trade.
The sub-prime problem and other growth issues have placed markets at a critical point that IMHO has the potential to turn on what the Fed says on Wednesday. Like everyone else I don't expect a rate change, but I do believe that the statement afterwards will be very, very important because it's likely to point the markets into a long term trend.
Let me first explain what an inflation bias means. Simply put, it's when the Fed believes there are more potential risks to the economy from inflation then from slower growth.
Right now, the Fed has (and has had since it stopped tightening) an inflation bias and as long this remains, the further the prospect of a rate cut is pushed out into the future. Equity markets would love to see a change towards a neutral bias at this time and I believe equities will weaken further in the coming weeks without one. Whether a change in the bias happens or not remains to be seen, so let's first review what the Fed has said and then i'll look at some scenarios that could play out. From the last statment on Jan 31:
Recent indicators have suggested somewhat firmer economic growth, and some tentative signs of stabilization have appeared in the housing market. Overall, the economy seems likely to expand at a moderate pace over coming quarters.
I would suggset that those tentative signs of housing stabilization have dissapated and the timing of moderate growth in the economy is more questionable. Bernanke repeated the line regarding the outlook on the pace of economic expansion in his congressional testimony. Other Fed govs have repeated this in recent speeches also.
Readings on core inflation have improved modestly in recent months, and inflation pressures seem likely to moderate over time. However, the high level of resource utilization has the potential to sustain inflation pressures.
The readings on wholesale and consumer level core inflation have gotten worse so far this year. Consumer coreCPI is on a 3% YoY basis vs. a 2.6% rate for all of 2006.
The Committee judges that some inflation risks remain.
If risks remained as inflation was "modestly" improving, where do they remain now?
We'll compare the new statement to the old on Wednesday. In the mean time, let's take a look at what could happen.
I don't believe that they will be able to change their inflation bias and I believe they will have to mention that housing has the potential to slow or push out the pace of economic expansion, although they could mention that the job market remains strong and consumer spending has continued to expand. Still, what we're going to do is read the statement, compare it to the old statement and gather opinion from the published news sources.
If it becomes apparent that the inflation bias remains I feel very strongly that equity markets will continue to trend down for some time to come because the sub prime problem will look to get worse and possibly spread while the prospect for a rate cut will be pushed out into the future. If the inflation bias is moved to a neutral bias I believe equities will trend up, because the sub prime problem could be judged to be contained while a rate cut will look more certain. Now here's how I would look to trade that:
I'm going to focus on a pair that some of you may not be used to looking at, the GBP/JPY. Take a look at a chart on this if you haven't-you'll be amazed at how much it moves. After you do that, take a look at a DJIA chart and compare that to the price movement on the GBP/JPY. You'll be amazed at the correlation. While you're at it, compare the GBP/JPY to charts of the FTSE and Nikkei too.
In the meantime, we'll continue to discuss this and I would also pay attention to Tuesday's housing number. Don't be surprised to see equities and the GBP/JPY drop off a negative print there. I would judge the reverse to be true also.
The sub-prime problem and other growth issues have placed markets at a critical point that IMHO has the potential to turn on what the Fed says on Wednesday. Like everyone else I don't expect a rate change, but I do believe that the statement afterwards will be very, very important because it's likely to point the markets into a long term trend.
Let me first explain what an inflation bias means. Simply put, it's when the Fed believes there are more potential risks to the economy from inflation then from slower growth.
Right now, the Fed has (and has had since it stopped tightening) an inflation bias and as long this remains, the further the prospect of a rate cut is pushed out into the future. Equity markets would love to see a change towards a neutral bias at this time and I believe equities will weaken further in the coming weeks without one. Whether a change in the bias happens or not remains to be seen, so let's first review what the Fed has said and then i'll look at some scenarios that could play out. From the last statment on Jan 31:
Recent indicators have suggested somewhat firmer economic growth, and some tentative signs of stabilization have appeared in the housing market. Overall, the economy seems likely to expand at a moderate pace over coming quarters.
I would suggset that those tentative signs of housing stabilization have dissapated and the timing of moderate growth in the economy is more questionable. Bernanke repeated the line regarding the outlook on the pace of economic expansion in his congressional testimony. Other Fed govs have repeated this in recent speeches also.
Readings on core inflation have improved modestly in recent months, and inflation pressures seem likely to moderate over time. However, the high level of resource utilization has the potential to sustain inflation pressures.
The readings on wholesale and consumer level core inflation have gotten worse so far this year. Consumer coreCPI is on a 3% YoY basis vs. a 2.6% rate for all of 2006.
The Committee judges that some inflation risks remain.
If risks remained as inflation was "modestly" improving, where do they remain now?
We'll compare the new statement to the old on Wednesday. In the mean time, let's take a look at what could happen.
I don't believe that they will be able to change their inflation bias and I believe they will have to mention that housing has the potential to slow or push out the pace of economic expansion, although they could mention that the job market remains strong and consumer spending has continued to expand. Still, what we're going to do is read the statement, compare it to the old statement and gather opinion from the published news sources.
If it becomes apparent that the inflation bias remains I feel very strongly that equity markets will continue to trend down for some time to come because the sub prime problem will look to get worse and possibly spread while the prospect for a rate cut will be pushed out into the future. If the inflation bias is moved to a neutral bias I believe equities will trend up, because the sub prime problem could be judged to be contained while a rate cut will look more certain. Now here's how I would look to trade that:
I'm going to focus on a pair that some of you may not be used to looking at, the GBP/JPY. Take a look at a chart on this if you haven't-you'll be amazed at how much it moves. After you do that, take a look at a DJIA chart and compare that to the price movement on the GBP/JPY. You'll be amazed at the correlation. While you're at it, compare the GBP/JPY to charts of the FTSE and Nikkei too.
In the meantime, we'll continue to discuss this and I would also pay attention to Tuesday's housing number. Don't be surprised to see equities and the GBP/JPY drop off a negative print there. I would judge the reverse to be true also.