Goldman Refuses To Stop Crushing Its FX Clients: "We Hold To Our Dollar Bullish Call"

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  1. admin

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    The predictive ability of Goldman's FX team is well known around here, and maybe is second only to Dennis Gartman in its "fadability". For those unfamiliar, here are some recent examples:

    And those, of course, exclude the stories about Goldman's legendary .000 batting Thomas Stolper.
    So after having been dead wrong on the reaction to the USD during three out of the past three major central bank announcements, has Goldman's FX strategist Robin Brooks finally thrown in the towel on his ongoing, and wrong, strong USD call?
    Not at all.
    Here is his latest note title "Check Please, Chair Yellen", in which he says "In line with our Fed view, we hold to our Dollar bullish call."
    * * *
    Last week’s speech by Chair Yellen laid out a clear narrative for the Fed’s dovish shift. The narrative goes that market turmoil in Q1, in part because of anxiety over RMB devaluation (Exhibit 1), caused markets to scale back their expectations for rate hikes, which helped insulate the US economy from adverse repercussions. The Fed thus needed to shift dovish, in order to validate the shift in market expectations. That is certainly a reasonable narrative; it just isn’t what happened. The SPX and front-end rates have been positively correlated since August, as both have been buffeted by the ebb and flow of RMB devaluation fears. In the run-up to the last FOMC, those fears were abating, causing risk to rally and the front-end to price back hikes. The Fed shift was thus a genuine dovish impulse, causing the Dollar to fall and US equities to outperform. In this FX Views, we review key elements of the Fed narrative (focusing on speeches by Chair Yellen and Governor Brainard) and argue that the dovish shift is: (i) unlikely to last long, given that the narrative behind the shift does not mesh well with how markets traded, i.e., is arguably quite weak; and (ii) is not obviously risk positive, given that it boosts US growth at the expense of the Euro zone and Japan, i.e., tilts growth away from where it is needed most. In line with our Fed view, we hold to our Dollar bullish call.
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    The narrative behind the recent Fed shift was laid out clearly in recent speeches by Chair Yellen (on Mar. 29 at the Economic Club of New York) and by Governor Brainard (on Feb. 26 at the Monetary Policy Forum). However, elements of that narrative do not line up well with our sense of markets:

    • Chair Yellen argued that a rally in front-end interest rates helped insulate the economy from market turmoil in Q1, much of which was related to “market confusion over China’s FX policy.” The Fed therefore needed to validate the change in market expectations by shifting dovish. This is not our perception of markets. Since August, stocks and front-end rates have been positively correlated (Exhibit 2), with the SPX and 2-year Treasury yield rebounding from mid-February, following reassuring comments by the PBoC Governor on the RMB. The Fed therefore gave a genuinely dovish impulse to an already rebounding market, causing US equities to outperform (Exhibit 3). This isn’t obviously bullish for risk globally, given that it shifts growth to the US from the Euro zone and Japan, places that arguably need it much more (Exhibit 4).
    • Chair Yellen also argued that lower front-end rates mean that the market recognizes the Fed’s data dependence. We disagree. The beta of front-end rates to our proprietary US MAP data surprise series has fallen back to the lows seen during calendar guidance (Exhibit 5), so that the market's perception of data dependence is arguably back to the days of 2011/12. The recent rally in front-end rates, instead, is more about a perception that the Fed is very dovish.
    • Governor Brainard argued that the “sensitivity of exchange rate movements to economic news and to changes in foreign monetary policy appears to have been relatively elevated recently,” in an argument that unconventional monetary policy “may contribute more to shifting of demand across borders than boost overall (global) demand.” This point is important, because it signals a potential shift in view on QE, emphasizing the beggar-thy-neighbor aspect over increased global monetary policy accommodation. While the beta of the broad Dollar to US MAP surprises rose as forward guidance was unwound, it has since fallen and is now borderline insignificant.
    • Finally, Governor Brainard argued that the divergence theme is outdated, given that inflation is so similar across the US, Japan and the Euro zone. But she also states that falling import prices (due to Dollar strength) “subtracted an estimated ½ percentage point from core PCE inflation,” essentially making the point that underlying divergence is stronger than meets the eye, one of our 10 commandments for this year.
    [​IMG]
    The Fed’s narrative therefore looks somewhat at odds with how markets have behaved. This leaves open two interpretations. First, it is possible that the underlying reaction function has always been dovish and that these are just the latest talking points. This is certainly what the market looks to be pricing, with less than one hike priced cumulatively through the end of 2016. In this case, there is hardly any point obsessing over whether this or that talking point makes sense, because these are just placeholders for a dovish policy stance. Second, the narrative may be a weak one, something of a lagged response to the ructions of Q1. This could see the Fed shift hawkish again, in line with our US economists’ view for three hikes this year.
    [​IMG]
    We think there are two paths from here. One is what the market is pricing, a world where the Dollar is kept in check by a dovish Fed and restraint from those central banks (the BoJ and ECB) facing genuinely low inflation. We think this scenario is difficult for risk assets outside of the US, because underlying imbalances in the G10 are still heavily monetary in origin, i.e., too little monetary accommodation in Europe and Japan and, arguably, too much in the US. The second is for monetary policy in the G10 to finish the job, which will mean a stronger Dollar, though obviously not in a straight line. After all, the past year has shown that Dollar strength is a deflationary shock, which periodically causes the Fed to shift in a dovish direction. We see this scenario as more risk positive, because additional monetary impulses from Europe and Japan will buffer less accommodation out of the US. Such a scenario would also allow the fix for $/CNY to move higher in order for the RMB to be roughly stable in trade weighted terms, i.e., would not necessarily be negative for EM. Our view is still that policy makers will converge to the second scenario, which is what our forecasts reflect.
    * * *
    What is perhaps most ironic about Brooks' note is that this "strong dollar" note hits the tape just days after another Goldman strategist admitted he was wrong about the "Yellen Call", which is the assumption that Yellen would care less about markets going forward, and more about the economy. So much for that.
    As for Goldman's persistent long dollar call, here is what the USD has done today....
    [​IMG]

    ... and in 2016.
    [​IMG]

    Actually, purely based on statistics, it is long overdue for Goldman to be finally correct. Perhaps going long the USD here is not such a bad idea, especially with Kuroda and Draghi both about to claw their eyes out as a result of the relentless strength of the Yen and the Euro.
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