Whither (Wither?) Profits

April 22, 2015 4 comments

Surprisingly, markets are treading water here. The dollar, interest rates, and stocks are all oscillating in a narrow range. In some ways, this is surprising. It does not shock me that interest rates are fairly boring right now, with the 10-year yield trading almost exclusively within 25bps of 2% since November. Market participants are divided between those who see the Fed’s cessation of QE as indicative that prices should decline to fair market-clearing levels (that is, higher yields) and those who see weakness economically both domestically and abroad. There is room for confusion here.

I am similarly not terribly shocked that the dollar is consolidating after a long run, especially when part of that run was fueled by the popular delusion that the Federal Reserve had suddenly become extremely hawkish and would preemptively hike rates before convincing signs of inflation arose. I am hard-pressed to think of a time when the Fed pre-emptively did anything, but that was the popular belief in any event. Now that it is becoming clear that a hike in rates in June is about as likely as the possibility that the Easter Bunny will deliver eggs at the same time, dollar traders who were relying on widening interest rate differentials are pausing to take stock of the situation. I will say that it certainly seems plausible to me that the dollar’s rally will continue for at least a little while, due to the volatility coming our way as the Greek drama plays out, but the buck is not an automatic buy either. Money growth in the U.S. continues to outpace money growth in most other economies (see chart, source Bloomberg), although it is a much closer thing these days.

allems

An increase in relative supply, if the demand curves are similar, should provoke a decrease in relative price. Unless you believe that the Fed isn’t just going to increase rates but is also going to shrink its balance sheet so that money growth abates eventually, it is hard to envision the dollar launching continuously higher. More likely is that as more and more currencies see their supplies increase, the exchange rates meander but the whole kit-and-kaboodle loses ground to real assets.

One of those real assets is housing. An underpinning to my argument, for several years running now, that core prices were not going to be deflating any time soon was the observation that housing prices (and hence rents, with a lag) have been rising rapidly once again. The deceleration in the year/year growth rates in 2014 was a positive sign, but the increase in prices in 2012 and 2013 is still pressing rents higher now and any sag in rents is yet to be felt. However, today’s release of FHA price index data as well as the Existing Home Sales report suggests that it is premature to expect this second housing bubble to unwind gently. The chart below is the year/year change in the median price of existing homes (source: Bloomberg). The recent dip now seems to have been an aberration, and indeed the slowdown in 2014 may have merely presaged the next acceleration higher.

ehslmp

And that bodes ill for core (median) price pressures, which have been steady around 2.2% for a while but may also be readying for the next leg up. Review my post-CPI summary for some of the fascinating details! (Well, fascinating to me.)

This doesn’t mean that I am sanguine about growth, either domestic or global, looking forward. I thought we would get out of 2014 without a recession, but I am less sure about 2015. Europe is going to do better, thanks to weaker energy and a weaker currency (although the weaker currency counteracts some of the energy weakness), but the structural problems in Europe are profound and the exit of Greece will cause turmoil in the banks. But US growth is in trouble: the benefit from lower energy prices is diffuse, while the pain from lower energy prices is concentrated in a way it hasn’t been in the past. And the dollar strength pressures company earnings, as we have seen, on a broad basis. And that’s where it is a little surprising that we are seeing water-treading. It gets increasingly difficult for me to figure out what equity buyers are seeing. Profits are flattening out and even weakening, and they are already at a very high level of GDP so that any economic weakness is going to be felt in profits directly. Furthermore, I find it very interesting that the last time actual reported profits diverged from “Kalecki Profits” corresponded to the last equity bubble (see chart, source Bloomberg).

kalecki

“Kalecki Profits” is a line that computes corporate profits as Investment minus Household Savings minus Government Savings minus Foreign Savings plus Dividends. Look up Kalecki Profit Equation on Wikipedia for a further explanation. The “Corp Business Prof After Tax” is from the Federal Reserve’s Flow of Funds Z.1 report and is measured directly. The implication is that if companies are reporting greater profits than the sum of the whole, then the difference is suspect. For example, leverage: by increasing financial leverage, the same top line creates more of a bottom line (in either direction). The chart below (source: Federal Reserve; Enduring Investments analysis) plots the 1-year percentage change in business debt outstanding (lagged 2 quarters to center it on the year in question) versus the difference between the two lines in the prior chart.

explaindiverg

We might call this “pretty cool,” but in econometrics terms this is merely an explanatory relationship. That is, it doesn’t really help us other than to help explain why the two series diverge. It doesn’t, for example, tell us whether Kalecki profits will converge upwards to reported profits, or whether reported profits will decline; it doesn’t tell us whether it is a decline or deceleration in business debt outstanding that prompts that convergence or whether something else causes both things to happen. I think it’s unlikely that the divergence in the two profit measures causes the change in debt, but it’s possible. I will say that this last chart makes me more comfortable that the Kalecki equation isn’t broken, but merely that it isn’t capturing everything. And my argument, for what it is worth, would be that business leverage cannot increase without bound. At some point, business borrowing will decline.

It does not look like that is happening yet. I have been reading recently about how credit officers have been declining credit more frequently recently. That may be true, but it isn’t resulting in slower credit growth. Commercial bank credit growth, according to the Fed’s H.8 report and illustrated below, continues to grow at the fastest y/y pace since well before the crisis.

cbcredit

If credit officers are really declining credit more often than before, it must mean that applications are up, or that the credit is being extended on fewer loans (that is, to bigger borrowers). Otherwise, we can’t square the fact that there’s rapid credit growth with the proffered fact that credit is being declined more often.

There is a lot to sort through here, but the bottom line is this: I have no idea what the dollar is going to do. I am not sure what the bond market will do. I have no idea what stocks will do. But, if I have to invest (and I do!), then in general I am aiming for real assets and avoiding financial assets.

Summary of My Post-CPI Tweets

April 17, 2015 3 comments

Below you can find a recap and extension of my post-CPI tweets. You can follow me @inflation_guy or sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments.

  • Core CPI+0.23% m/m is the story, with y/y upticking to 1.754% (rounded to +1.8%). This was higher than expected, by a smidge.
  • Core services +2.4% y/y down from 2.5%. But core goods -0.2%, up from -0.5% last mo and -0.8% two months ago. Despite dollar strength!
  • Core ex-housing rose to 0.91% y/y from 0.69% at the end of 2014. Another sign core inflation has bottomed and is heading back to median.
  • The m/m rise of 0.20% in core ex-shelter was the highest since Jan 2013.
  • Primary rents 3.53% y/y from 3.54%; OER 2.693% from 2.687%. Zzzzz…story today is outside of housing, which is significant.
  • Accelerating major groups: Apparel, Transport, Med Care, Recreation (32.1% of index). Decel: Food/Bev, Housing, Educ/Comm, Other (67.9%)
  • …but again, in housing the shelter component (32.7% of overall CPI) was unch at ~3% while fuels/utilities plunged to -2.26% from flat.
  • [in response to a question “Michael we have been scratching our heads on this one… is it some impact of port strike do you think?”] @econhedge I don’t think so. But core goods was just too low. Our proxy says this is about right.
  • @econhedge w/in core goods, Medical commodities went to 4.2% from 3.9%, new cars from 0.1% to 0.3%, and Apparel to -0.5% from -0.8%.
  • @econhedge so you can argue Obamacare effect having as much impact as port strike. But it’s one month in any case. Don’t overanalyze. :-)
  • Medicinal drugs at 4.46% y/y. In mid-2013 it was flat. That was a big reason core CPI initially diverged from median. Sequester effect.
  • @econhedge Drugs 1.70%, med equip/supplies 0.08% (that’s percentage of overall CPI). 8.7% and 0.4% of core goods, respectively.
  • Median should be roughly 0.2%. I have it up 0.21% m/m and 2.22% y/y, but I don’t have the right seasonals for the regional OERs.
  • Further breakdown of medical care commodities: the biggest piece was prescription drugs, +5.74% y/y vs 5.19%. The other parts were lower.

The main headline of the story is that core inflation rose the most month-over-month since May. After a long string of sub-0.2% prints (that sometimes rounded up), this was a clean print that would annualize to 2.7% or so. And it is no fluke. The rise was broad-based, with 63% of the components at least 2% above deflation (see chart, source Enduring Investments, and keep in mind that anything energy-related is not part of that 63%) and nearly a quarter of the basket above 3%.

abovezero

This is no real surprise. Median has consistently been well above core CPI, which implied some “tail categories” were dragging down core CPI. These tail categories are still there (see chart, source Enduring Investments), but less than they had been (compare to chart here). Ergo, core is converging upward to median CPI. As predicted.

distrib

The next important step in the evolution of inflation will be when median inflation turns decisively higher, which we think will happen soon. But that being said, a few more months of core inflation accelerating on a year/year basis will get the attention of the moderates on the Federal Reserve Board. I don’t think it will matter until the doves also take notice, and this is unlikely to happen when the economy is slowing, as it appears to be doing. I don’t think we will see a Fed hike this year.

Two Quick Items

Two relatively quick items that I want to address today; they have been in my ‘to do’ box for a while.

Negative Rates

One of the most interesting features of the fixed-income landscape today, and one that will likely serve in the future as an exam question on finance quizzes, is the increasingly widespread proliferation of negative nominal interest rates among government bond markets…and occasionally even for high-quality corporate paper.

In finance theory, this can’t happen. Because currency earns a 0% nominal interest rate, theory says that no rational person would ever accept a negative nominal interest rate. If I have $50 today, and put it in the bank, I will have $49 tomorrow. So why not just keep the $50 in my wallet? (Obviously this leads to high cash balances, which means low monetary velocity, by the way). And this is true in the absence of “other costs.”

So why are so many interest rates negative? Are individuals irrational? No: at least not so irrational that they prefer less money to more money. However, what is true at an individual level does not necessarily scale to the institutional level. An institution, such as a money fund or corporation, does not have the freedom to hold its assets in physical currency. Microsoft has $90 billion in cash and equivalents. If this were in $100 bills, it would weigh about one thousand tons. That’s a pretty big vault. And vaults cost money. Guards cost money. And, if Microsoft had this money in the vault, it would be harder to spend. It is much easier to wire $5 million than it is to send an armored car.

In the presence of those costs, Microsoft and other institutions will accept a negative interest rate. It will invest its money at a negative rate rather than build a vault.

Now, an important (if obvious) point is that cash balances are so high, and interest rates so low, because global central banks are making sure we have plenty of cash. Too much cash chasing too few investment opportunities causes rates to be low.

Walmart and Minimum Wage Increases

It has been a few weeks now, but when Walmart in February announced it was going to increase the minimum wages it plans to pay its employees (preceded by Starbucks, Aetna, and the Gap and followed by TJX and Target), I received a number of queries about what the hike was going to do to inflation. Is this the beginning of the much-feared “cost-push inflation”?

The answer is no. Wages, as I have said many times, follow inflation rather than lead it. Think about it: wouldn’t it be really weird for companies to raise wages and then raise prices, to the extent that they have control – at least with respect to timing – over both? No, whatever price increase is going to be caused by the increase in the wages Walmart expects to pay is already in the price. Walmart is not surprised by their own move to raise wages. Nor is anyone surprised by the general increase in the minimum wage, which happened in 2009.

So, while I continue to believe that inflation is rising, and will continue to rise…I don’t believe that the increase in prices is going to be any faster due to these wage increases. It does, however, increase my confidence that inflation is rising, since obviously these retailers are confident enough in the pricing environment to be able to increase wages (which are sticky – it is harder to lower them than to raise them).

Lots to Worry About but Nothing to Fear?

As we tick towards the end of the quarter, the news feeds are starting to look like they occasionally do when we are having a big spike in volatility.

We have the Greece deadline coming up. I don’t think anyone knows exactly when Greece’s finances will hit the wall, but it is going to be soon. And, compared with prior incarnations of this exact same crisis, there doesn’t seem to be nearly as much optimism about the probability of a “positive” resolution to this crisis. By “positive,” I mean in the sense that the status quo remains more or less preserved: Greece gets money, and pledges reforms, but nothing actually happens except that Greece’s depression continues. I don’t at all mean positive from the standpoint of the Greeks (I continue to think they will be better off in the medium-term to exit the Eurozone and default on Euro-denominated debt), or even from the standpoint of the Euro (assuming the single currency survives, the departure of Greece will be an important test case for the ramifications of re-shaping the currency bloc to a sturdier subset of countries that intend to move towards fiscal union). Interestingly, and in contrast to prior iterations of the exact same crisis, both sides appear to understand that Grexit does not mean disaster, and to perceive the possibility that it might make sense to let this happen – since, in any event, it is inevitable. There seems to be little urgency to craft a real deal, and the panicky increase in market volatility is missing this time.

The Middle East is increasingly in flames. What I call the “black I’s” of Iran, Iraq, and ISIS are as unstable as ever, but now Yemen is in civil war with the existing government fighting Iranian-backed rebels and today Saudi Arabia plunged into the fight as a counterweight to Iran’s influence.  The comments that this should be only a short-term influence on crude oil prices because “the market remains oversupplied” make two assumptions that are possibly questionable here.

One is the technical point that the oil market is oversupplied (true), but that this means current prices should not react to disruptions to future supply. Of course, that is wrong: if it was suddenly discovered that all oil in the world was scheduled to evaporate on January 1st, 2020, you can bet your bottom petrodollar that prices today would (and should) react, even though that date is far in the future. Efficient markets reflect not only spot supply and demand, but also discount expectations for future changes in supply and demand (at least, for commodities that are storable at a reasonable cost).

The second assumption that may be questionable is whether the battle over Yemen is just a skirmish over a country with a small oil production footprint. Indeed, that may be the case. However, the appearance of Saudi Arabia into the fray does make one wonder whether the Saudi Kingdom does see a bigger conflict at play here. To the extent that Yemen is an opportunity for Sunnis (most of the Arab world) and Shia (Iran, most of Iraq) to engage indirectly, it signals rising structural tensions in the region and the possibility for much wider conflict. An analogy might be the Cold War phenomenon of the US and the USSR engaging in conflict by proxy; that conflict never emerged into a hot war but that didn’t make those of us hiding under our desks any more confident in the stability of the situation.

I don’t have a strong opinion on whether either assumption is warranted, but it strikes me that markets for implied volatility ought to be somewhat more bid on either possibility, not to mention what is happening in Greece. And yet, they’re not. The two charts below (source: Bloomberg) show the VIX and the MOVE (for bonds). Neither seems to be displaying much alarm at this point. It feels like we should be having a spike in volatility, but we are not. To me, this makes the buying of protective puts an attractive alternative to consider.

vix

move

Categories: Bond Market Tags: , ,

Summary of my Post-CPI Tweets

Below you can find a recap and extension of my post-CPI tweets. You can follow me @inflation_guy or sign up for email updates to my occasional articles here. Investors with interests in this area be sure to stop by Enduring Investments.

  • core CPI +0.157%, so it just barely rounded to +0.2%. Still an upside surprise. Y/Y rose to 1.69%, rounding to 1.7%.
  • y/y headline now +0.0%. It will probably still dip back negative until the gasoline crash is done, but this messes up the “deflation meme”
  • (Although the deflation meme was always a crock since core is 1.7% and rising, and median is higher).
  • Core ex-housing +0.78%. Still weak.
  • Core services +2.5%. Core goods -0.5%, which is actually a mild acceleration. So the rise in core actually came from the goods side.
  • Accelerating major cats: Apparel, Transp. Decel: Food/Bev, Housing, Med care, Recreation, Other. Unch: Educ/Comm. But lots of asterisks.
  • Shelter component of housing rose back to 3% (2.98%) y/y; was just fuels & utilities dragging down housing.
  • Primary rents: +3.54% y/y, a new high. Owners’ Equiv Rent: 2.69%, just off the highs.
  • In Medical Care, Medicinal Drugs 4.13% from 4.16%, but pro services +1.47 from +1.71 and hospital services 3.28% from 4.08%.
  • In Education and Communication: Education decelerated to 3.5% from 3.7%; Communication accel to -2.2% from -2.3%.
  • 10y breakevens +3bps. Funny how mild surprises (Fed, CPI) just run roughshod over the shorts who are convinced deflation is destiny.
  • No big $ reaction. FX guys can’t decide if CPI bullish (Fed maybe changes mind and goes hawkish!) or bearish (inflation hurts curncy).
  • Here’s my take: Fed isn’t going to be hawkish. Maybe ever. So this should be a negative for the USD.

This CPI report was a smidge strong, but just a smidge. The market was looking for something around 0.12% or so on core, and instead got 0.16%. To be sure, this is another report that shows no sign of primary deflation, but still it amazes me that inflation breakevens can have such a significant reaction to what was actually just a mild surprise. That reaction tells you how pervasive the “deflation meme” has become – the notion that the economies of the world are headed towards a deflationary debt spiral. I am not saying that cannot happen, but I am saying that it will not happen unless somehow the central banks of the world decide to stop flushing money into the system. And honestly, I see no sign whatsoever that that is about to happen.

As I wrote last week, it should be no surprise that this is a dovish Fed that will perpetually look for reasons to not tighten, and will do so only when the market demands it. My guess is that will happen once inflation, breakevens, and rates rise, and stocks fall. And this doesn’t look imminent.

Outside of housing, core inflation still looks soft. But housing inflation is accelerating further, as has been our core view for some time. The chart below (data source: Bloomberg) shows the y/y change in primary rents is at 3.54%. The median in primary rents for the period for 1995-2008 (the 13 years leading up to the crisis) was 3.20%. And during that time, core inflation ex-housing was 1.72% (median).

primrents

Like most data, you can use this to argue two diametrically-opposed positions. You might argue that the Fed’s loose money policy has helped re-kindle a bubble in housing, as inflation in rents of 3.54% with other core prices rising at 0.78% suggests that housing is in a world of its own. Therefore, the Fed ought to be removing stimulus, and tightening policy, to address the bubble in housing (and the one in equities) and to keep that bubble from bleeding into other markets and pushing general prices higher. But the flip side of the argument is that core inflation outside of housing is only 0.78%, so therefore if the FOMC starts removing liquidity then we may have primary deflation, ex housing. Accordingly, damn the torpedoes and full steam ahead on easing.

The data itself can be used right now to make either argument. Which one do you think the Fed will make?

Follow-up question: given that the Fed has historically one of the worst forecasting records imaginable, which argument do you think is actually closer to correct?

 

That’s Not How Any of This Works

March 18, 2015 1 comment

I wonder how many times the Fed needs to be more dovish than expected before investors realize that this is a dovish Fed?

It may indeed be the most dovish Fed ever, judging from Dr. Yellen’s prior statements and history. And yet, investors seemed to have convinced themselves that with core inflation measured in the Fed’s preferred way far below its target (to be sure, it’s not the right way to measure it, but they’re not looking for excuses to hike), with structural unemployment still high (see chart of “Not in Labor Force, Want a Job Now,” source Bloomberg, below), with other central banks aggressively easing so that our dollar is aggressively strengthening, and with recent economic indicators surprising on the low side at the most-rapid pace since 2011, the Fed was going to put itself on a track to start hiking rates by early summer.

wanna

In the event, the Fed told us that they are no longer going to be automatically “patient” – which was the word that 90% of economists expected them to remove from the statement – but the Committee’s median projections for the year-end Fed funds rate dropped 50bps since the last meeting, to just above 0.5%.

Why won’t investors listen? It isn’t as if the last Fed Chairman was a renowned hawk. It’s been a generation since we had a real hawk in the Chairman’s seat. So I have no idea why it is a shock to people that the Fed acts dovishly, even as Chairman Yellen says the Fed will need to “monitor inflation developments carefully.”

If they were monitoring inflation developments carefully, they would know that median inflation is already at levels that represent achievement of the Fed’s target. If they were monitoring inflation developments carefully, then they would know that the dollar (which Yellen says will keep inflation lower for longer) has very little impact on domestic pricing, outside of goods that are largely produced overseas (apparel) or certain raw commodities (like energies).

Or, perhaps, just perhaps…they actually do know these things, but prefer to rely on obfuscation to keep rates as low as they can for as long as they can, until the market absolutely demands that they raise them. With market interest rates low, and the dollar strong, there is absolutely no market pressure for the FOMC to raise rates. Therefore, they will not.

At this writing, 10-year breakevens are +11bps on the day. Over the last week or two, after a mild bounce from the beaten-down lows, fast money had been leaning on breakevens again and pushing them inexorably lower. How do I know it was fast money? Because 10-year breakevens are up 11bps in a freaking hour, after a mild adjustment in the “dots.” That isn’t the sort of move that reflects long-term planning.

I continue to be flabbergasted at how the Fed maintains its credibility. We all know that the Fed has been considerably worse than the average economic forecaster over a long period of time. But it even seems to have trouble with current data. On the tape right now, the Chairman is saying that the “residual effects” of the financial crisis are restraining credit. Really? The chart below shows commercial bank credit. Does that look restrained to you? It is rising at better than an 8% pace y/y, the fastest level since May 2008. And it’s 10%-11% annualized on a q/q basis.

cbcredit

Sometimes I want to echo that commercial for Esurance. “That’s not how it works. That’s not how any of this works.”

When market rates go higher, and/or the dollar weakens because our domestic inflation starts being appreciably more than that of our trading partners, then the Fed will get serious about tightening. But it will have to be serious enough to handle the downward adjustment in securities prices that will happen when they begin to do so. I can’t foresee a time when that’s particularly likely. The Fed eschewed tightening over the last few years with an economy that had good momentum (see the first chart above). How likely is it that the Fed will get ambitious about hiking rates in the late stages of an expansion that is long in the tooth? With this Chairman? I wouldn’t hold your breath.

Categories: Bond Market, Federal Reserve, Rant Tags:

Just One Thing

March 12, 2015 3 comments

The defining characteristics of the markets these days seem to include:

  1. Central bank liquidity matters; central government mistakes do not.
  2. Central bank liquidity matters; economic growth numbers do not.
  3. Central bank liquidity matters; market illiquidity does not.
  4. Central bank liquidity matters; and so does the dollar (but that’s just a manifestation of the fact that central bank liquidity matters).

You may notice some commonality about the four defining characteristics as I have enumerated them above. I will add that this commonality – that seemingly only central bank liquidity operations matter these days – is also the reason that I haven’t been writing as much these last days, weeks, and months. As someone who has watched the Fed for a long time, I might have a decent guess as to when the Fed might change course…but probably no better than many other watchers. (Moreover, as I have said before, whether the Fed actually hikes rates or not probably doesn’t matter either as long as there is adequate liquidity, which is a question independent at the moment from rates. Refer again to the four characteristics.)

Let us take these one at a time.

Central bank mistakes don’t matter as much as the question of whether central banks are adding enough liquidity. Exhibit A is the fact that 10-year yields are negative in Switzerland, under 1% in France, Germany, Sweden, and the Netherlands, and under 1.60% in (get this) Italy, Spain, and Portugal. This is despite the fact that Greece is likely to leave the Euro either sooner or later, provoking existential questions about whether Italy, Spain, Portugal, and maybe France can also remain in the Eurozone. We can debate whether “likely to leave the Euro” means 20% chance or 80% chance, but if the chance is not negligible – and it certainly looks to be something more than negligible – then it is incredible that the Italian, Portuguese, and Spanish yields are all so low. Yes, it’s largely because of the ECB. Quod erat demonstrandum.

Economic growth numbers do not matter as much as central bank profligacy. The Citigroup Economic Surprise index for the US just fell below -50 for the first time since 2012 (see chart, source Bloomberg).

cesiusd

Now, weaker-than-expected data spelled bad news for stocks in 2008, 2010, and 2011, but not since then. I wonder why? Right: central bank liquidity trumps. Quod erat demonstrandum.

Recently, I have read a fair amount about increasingly-frequent bouts of illiquidity in various markets. The US TIPS market has comfortably more than a trillion dollars’ worth of outstanding issues, but has been whipsawed unmercifully over the last week and a half (after, it should be said, a hellacious rebound from the outrageous selloff in H2 of last year – see chart of 10-year breakevens, source Bloomberg). But that market is not alone by any stretch of the imagination. Energy markets, individual stock names and the stock market generally, and the list goes on.

10y breaks

It isn’t that there has been dramatic volatility – volatility happens. It’s that the effective bid/offer spreads have been widening and the amount of securities that can be moved on the bid and offer has been declining (to say it another way, the real market for size has been widening, or the cost of liquidity has been rising). This in itself is not surprising: some pundits, myself included, predicted five years ago that instituting the Volcker Rule, and other elements of Dodd-Frank that tended to decrease the risk budgets of market liquidity-makers, would diminish market liquidity. (See here, here, and here for some examples of my own statements on the matter). But the other prediction, that markets would fall as a result of the diminished market liquidity – less-liquid stocks for example routinely trade at lower P/E ratios all else being equal – has proven incorrect. Why? I would suggest the central bank’s provision of extraordinary monetary liquidity has helped keep markets elevated despite thinning liquidity. Quod erat demonstrandum.

So what is there to write about? Well, I could talk about the dollar, which at +25% from last June is starting to be in the realm of interesting. But this too is just another manifestation of central bank shenanigans – specifically, the notion that every central bank is being easier than our Federal Reserve. So it comes back to the same thing.

So all roads lead to the question of central bank liquidity provision. This primal single-note drum-beat is, if nothing else, exquisitely boring. But boring isn’t as annoying as the fact that it’s also wrong. The Fed isn’t being any more hawkish this year than it was last year. The growth in the money supply – which is the only metric of significance in the WYSIWYG world of monetary policy – is pretty much at the same level it has been for three years: about 6.0%-6.5% growth year/year (see chart, source Enduring Investments). That’s also exactly where UK M2 growth has been. Japanese money growth, while a lot healthier at 3.5% than it was at 2%, is still not doing anything dramatic despite all of the talk of BOJ money printing (color me surprised, by the way).

M2s

About the only interesting move in money growth has been in the EZ, which is where observers have been the most skeptical. One year ago, M2 growth in the Eurozone was 2.5%; as of January 2015, it was 5.6%.

The weakness in the Euro, in short, makes sense. The supply of Euros is increasing relative to the former growth trajectories, compared to USD, GBP, and JPY. Increase the relative supply; decrease the price. But the dollar’s strength against the rest of the world does not make so much sense. The supply of dollars is still rising at 6.5% per year, and moreover nothing that the Fed is proposing to do with rates is likely to affect the rate of increase in the supply of dollars.

At the end of the day, then, characteristic #4 I listed at the beginning of this article is wrong. It’s the perception of central bank liquidity, and not the liquidity itself, that matters to currencies. And that’s why I think the dollar’s run is going to come to an abrupt end, unless M2 growth inexplicably slows. How soon that run will end I have no idea, but it seems out of bounds to me. At least, if actual central bank liquidity is what matters…and for everything else in the securities markets, it seems to.

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