Preview of the Federal Reserve decision on January 28, 2015. Here’s what the Fed should do.
The Fed got a dose of reality with its morning coffee on the first day of its two-day meeting. The durable goods orders reports was just awful.
Not just the headline, but the details …and the revisions. Orders fell a whopping 3.4% compared to +0.3% expected but that understates just how bad it was. The prior report was revised to -2.1% from -0.7%. It’s also the fifth consecutive month of flat or negative readings.
durable goods orders
Digging down into the data it got even worse.
A key factor in GDP is shipments but nondefense ex-air shipments fell 0.2% compared to +1.0% expected and that also goes along with a big negative revision on the prior down to -0.6% from +0.2%. So mark down Q4 GDP a few ticks.
But looking ahead is where it gets worse. Perhaps the most damning of all is the proxy for business investment — non-defense capital goods orders ex-air — that measure fell 0.6% compared to a 0.9% rise expected. Again it was compounded by a revision in the Nov data to -0.6% from 0.0%. It’s the fourth consecutive decline and the total level of business investment is barely above where it was in November 2013.
The Fed should reconsider any path towards tightening and it just might. After the report Morgan Stanley pushed back its Fed liftoff forecast to March 2016 from January 2016.
Fed chair Yellen didn’t promise to raise rates
The reasons to wait are mounting. Overseas economies are weak and the dollar will take care of inflation, which is nil anyway because of the plunge in commodities.
The thing is, the dollar strength so far may spark another round of soft business investment. Q4 earnings are seeping in and they’re been soft. Already Caterpillar, Pfizer, Proctor & Gamble, Microsoft, UTX and DuPont have warned about falling profitability due to the strong dollar. The dollar headwinds have only gotten worse since the end of the quarter.
What’s the FX trade if the Fed shifts back to neutral?
At this point it’s most likely the Fed simply maintains its current rhetoric about remaining patient on rate hikes. That will buy them until March to evaluate and the trend will be clear by then.
It might be comments from officials in the inter-meeting period rather than the statement that give away what’s next.
If the Fed instead takes a more dovish path and stops talking about a mid-year rate hike, the US dollar is vulnerable. The dollar trade is extremely crowded an event like a reversal in rhetoric at the Fed would spark a violent short squeeze that would initially help the euro soar and sink USD/JPY but over time the high yielders in Australian and New Zealand may have the most to gain — especially if central banks there maintain their stances.
Bottom line: The US dollar is soft after the durable goods report but the risks to the downside far outweigh the chances of a rebound if the Fed changes gears. That’s growing more likely and quick dollar shorts are attractive.
The FOMC decision is due at 2 pm ET (1900 GMT). There will be no forecasts or a press conference afterwards.
