It's Thomas Jefferson’s 272 birthday today, and the role of government and the invisible hand of capitalism haven't changed too much in the intervening years.
Throughout his life, Jefferson warned of the dangers of big government and big banking. In fact, Jefferson refused to renew the charter for the First Bank of the United States.
One of my favorite Jeffersonian quotes, and one of the most popular on the topic of central banking is: “The central bank is an institution of the most deadly hostility existing against the Principles and form of our Constitution. I am an Enemy to all banks discounting bills or notes for anything but Coin. If the American People allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the People of all their Property until their Children will wake up homeless on the continent their Fathers conquered. ”
I’m sure if Mr. Jefferson could see what’s going on now, he would be shaking his head and saying, “I told you so.”
More Fed Speak
The ord’s most important central bank was once again on display last week moving asset prices with the latest round of Fed minutes. Several of the participants stated that the economic data warranted the first rate hike be implemented at the June meeting.
Still others anticipated that the effects of energy price declines and the USD’s appreciation would continue to weigh on inflation in the near term, suggesting that it would be more appropriate to begin raising rates later in the year.
There were even a few participants that suggested that the US’s economic condition wouldn’t warrant the first rate hike until next year. The Fed statement discussed the strength of the USD as the primary reason that it cut its long-term forecasts but also noted that the stabilization of the USD would help boost confidence that inflationary readings would begin to move towards the Fed’s target of 2%.
The minutes also discussed a couple of international scenarios that the Fed is concerned about including: the slowdown in Chinese growth; the fiscal situation in Greece; and geopolitical tensions.
It should also be noted that the Fed minutes re-emphasized that policy would remain highly accommodative even after the first rate hike.
The net-net of the Fed minutes is that the probability of a June or September rate hike is far greater than most market participants believe. This means that the US divergence trade which has pushed the USD to a 10-year high is still very much in play.
If you will recall both the dovish spin on the March FOMC minutes as well as the disappointing ADP and NFP jobs numbers had called the divergence trade into question.
Last week’s Fed statement, combined with weekly jobless claims hovering around 15-year lows and an improving JOLTS report has begun to cast doubt as to whether that weak job growth in March represents anything significant and resulted in the USD having the biggest weekly gain since 2011.
Q1 And Done
Last week’s developments also back up my feeling that whatever headwinds the US experienced in Q1 will prove to be transitory. I haven’t read too much into the overall weakness of the economic data coming out of Q1 for two primary reasons.
First, the has been a clear pattern over the last 5 years where the US starts out the year on a soft note and then gets things rolling in the second half of the year. Over the last five years, Q1 growth has averaged 0.6% on an annualized basis versus a near 3.0% annualized growth rate for the remaining 3 quarters.
And in three of the last five years, Q1 growth has been the slowest growth rate of the entire year.
Will 2015 be a repeat? I'm betting, yes. The second development I’ve been watching which leads me to believe the weak Q1 pattern will continue and give way to stronger growth is what the markets are telling us about US growth.
In last week’s TWR, I mentioned that US High Growth assets are outperforming both US Slow Growth assets and the broader US equity market by a wide margin on a YTD basis. That margin got even wider last week and now High Growth assets are outperforming the S&P 500 by 240 basis points and their Slow Growth counterpart by 340 basis points. This tells me that the market is continuing to allocate resources for an acceleration in US growth towards the back half of 2015.
Jefferson also said “If you want something you’ve never had, you must be willing to do something you’ve never done before.”
This is one of my favorite quotes.
I’ve always interpreted this quote as being in favor of not only pushing your own personal limits but also of favoring a contrarian approach.
If you want to win in a highly competitive environment, then you better be willing to approach the game in a different way than your competitors. Trading in the financial markets is one of the most competitive industries out there and consistent profitability is downright hard to accomplish.
You and I are competing against banks, large investment firms and private funds who have substantially greater resources and substantially greater research staffs. In order to level the playing field and achieve consistent profitability, we must be willing to view the markets through a unique framework.
This is why I pay particular attention to how speculators, both large and small, are positioning themselves in various futures markets. History has proven that when positioning gets too lopsided, the market has a way of punishing the crowd.
That said, positions and the markets themselves can stay lopsided for long stretches of time, so you need more than just out of whack positioning to initiate a trade.
The fact that the LONG USD is probably the most crowded trade right now is not groundbreaking news. In fact, I’ve covered the topic in recent months. But I bring it up again today, because there has been almost no abatement in the USD’s advance, which began last summer and it’s now up another 9% year to date.
Despite the monster move up, large speculators, the smart money, are still holding record USD long positions and record low USD short positions. In fact, positioning is currently 3 standard deviations away from the historical norm. That’s the scientific way of saying that positioning is freaking lopsided.
And to add some context, the gross USD long positions have been increasing throughout this latest 9% rally. If you couple the current positioning with the fact that everyone and their mothers are discussing the USD’s strength, you have all of the makings of a contrarian trade, at least from a behavioral perspective.
However, in addition to having the sentiment leaning too far in one direction, you also need to have at least the fundamentals and ideally, the price action, to back your contrarian viewpoint.
Having 2 out of those 3 can be sufficient to initiate a contrarian trade idea. Having only 1 of the 3 all but guarantees you’ll get your face ripped off. Metaphorically speaking, of course.
Both the fundamentals and the price action are very pro-US Dollar. But as I said last week, markets are dynamic. What was true for a particular market last week, may no longer be true this week.
When sentiment shifts in a market, the price action can be violent as everyone runs for the door at the same time. Be particularly careful trading the LONG US Dollar right now and for that matter trading other markets closely linked to that particular trade.