Fed Could Shoot Itself in the Foot
Yellen once again pointed to consumers as a source of strength in the economy and added an upbeat note on housing in comments Monday. The Monday session saw the Canadian dollar as the top performer on higher oil prices while the US dollar and Aussie lagged. Today, gold, silver and the yen have led the European session into early US trading with CAD and NZD the biggest losers in thin trading. The Premium video on existing trades will be posted near the London close.
Yellen said the economy was pretty healthy and repeated that the plan is to gradually move rates to a more-neutral level if the economy cooperates. Her optimism was balanced by a warning that inflation is still below target in her view.
The market hardly reacted to her comments in what was a low-volatility day of trading. In general, expect currencies to move less on Fed statements about the economy, especially positive comments. The focus is more on interest rates and the market will wait for signals on hiking/holding rather than attempting to interpret economic thoughts.
What's interesting to note is that the consumer and housing are the backbone of the Fed's positive view. Housing isn't something that was previously emphasized but with supplies tightening in the US, it could be a powerful one. Valuations in most American cities are far below global prices as the scars from the crisis cut deep but they are fading and years of catch-up may be coming. What could endanger that theme the most is the Fed. If Yellen hikes 100 bps, buyers could be scared off.
Consumer remain fickle. The election has led to a surge in confidence but it hasn't been met with business investment and if that paradigm falters, the consumer could retrench. Again, credit is also critical because of the high level of consumer leverage. If rates go higher, tight lending could easily spending.
So both pillars of the Fed's upbeat model are sensitive to the Fed itself, along with a fluid political environment. So while Yellen (and markets) are confident now, any misstep could easily break the paradigm.
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