(MENAFN- ValueWalk) Inflation, sovereign debt and currency values have historically been correlated to various degrees. When they fall out of their correlation patterns, mean reversion has typically occurred. Given these as precepts, Deutsche Bank Foreign Exchange Macro Strategist Alan Ruskin looks at recent CPI data and connects what are at times noncorrelated dots.
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"Excuses don't count" for CPI data
For the last five months, the Consumer Price Index (CPI) has been rather . In July CPI data came in at .1 after posting losses of -.1 and -.3 in May and March respectively. For Ruskin, he sees a pattern that appears like childish behavior.
'Like a poorly behaved kid every month there is a new excuse,' he says, hoping for a strong number that shows the economy is strong and alive. At some point, however, the reality must be faced. 'After a while the excuses don't count.'
Looking back in history, the last time five consecutive CPI data downtrends occurred, the year was 2005 and the housing bubble 'heyday' was fast upon us. Ruskin, in an August 13 report titled 'Nine lessons from the CPI data,' notes that then, as is the case now, the Fed was encouraged to 'run the economy hot,' which pumped up asset prices, most notably seen in equities.
This CPI data concept was also a to the mid- to late-1990s, just before the bubble burst in 1998. With this memory as a backdrop, the Fed is looking to let the air out of the balloon before it pops.
The latest CPI data tells a slightly more nuanced story and has shifted market expectations for a Fed rate hike by 6%, Ruskin notes:
It is expected that it will be tough to lower the probability of a Dec hike below its current rate, near 20%. IF before the Dec FOMC meeting, the last 3m of core CPI is annualising near 2%, and the growth remains similarly robust with financial conditions easy, then it is still likely that the Fed will tighten by the end of the year. There is a significantly greater joint probability than 20% that this occurs. An even more straightforward trade relates to 2018 where there is only one hike priced between now and the end of next year. Either financial conditions tighten substantially (on say political risk) or the 2018 Fed is seriously mispriced.
CPI data asudem Currency volatility is leading markets, which is statistically out of sample behavior
When considering the correlation relationships between markets, bond traders, to some degree, are often considered leaders.
On a statistical basis, bond market volatility has most often proceeded other markets, who follow suit. But Ruskin notes a recent change in the. Currency volatility has led stock market volatility recently, with bond market volatility being the laggard. He thinks causation is due to geopolitical risk, particularly with North Korea. The low inflation reads, meanwhile, are pushing the back-end of the yield curve near its support, which is dampening moves to a degree. On the US Ten Year note that support is near 2.1%.
When looking at the US dollar, Ruskin is skeptical about US interest rates taking the lead in driving it much lower and, likewise, questions the Fed's influence. From the standpoint of the US dollar / Japanese yen trading pair, this means a buying zone could exist near the 107 to 108 yen level. The euro, on the other hand, 'has a life of its own,' as the currency is 'significantly outperforming' the interest rate spreads that normally price behavior to a larger degree.
How does the vaunted work in such environments? 'Carry is the King without cloths,' Ruskin quips:
Carry looks great versus the USD. The problem with FX carry is i) that broad based cumulative EMFX basket gains are strongly correlated with the EUR; and ii) that carry gains in EUR terms are weak (see Figure 8). The net conclusion is the EUR is the purer trade, especially if carry is more vulnerable to Korean political risk than the EUR.
It is difficult to determine if inflation has bottomed, as the recent anemic CPI data. Nonetheless, Deutsche Bank is eying a three-month annualized core CPI coming in close to 2%, a little higher than the current range, but it might not mean much. 'This possible source of support for the USD will be regarded by the market as too to change the negative USD tone,' Ruskin mused.
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