Economies are doing better than expected or at least that catastrophe is being postponed

Outlook: This is a big data day, starting with the manufacturing PMI, the ISM version, JOLTS, the BoC and the Beige Book, among other events. Earlier we will have gotten some PMIs from Europe.

The overall sense is that economies are doing better than expected or at least that catastrophe is being postponed. This is important because central bankers (and politicians) are making a big stink about inflation and in the background, economic conduct goes on as normally as it can.

The one giant problem today is supply chains, getting the blame for inflation in energy, food, and Stuff. But now Covid is mostly behind us, supply chain problems from that source “should” be fading. It’s taking longer than some would have thought. The supply chain is not a rubber band.

But it’s not a broken metal chain, either. You can still buy a new refrigerator or water purifier or t-shirts from Asia or a notebook PC or anything else, from Amazon, with free one-day delivery. We recently did all those things. With all the wailing and gnashing of teeth about the supply chain, for the average US consumer, it’s a non-event. Economically it’s a big deal (chips, autos) but not to the average Joe. This matters because US consumer sentiment is central to a big chunk of the upcoming global data.

Supply issues arising from the Chinese lockdown may be easing soon, too, but honestly, no one knows. That leaves supply issues arising from the Russian invasion of Ukraine, and those are intractable. We learned more about fertilizer than we ever wanted to know.

Bottom line, markets are coming to take supply issues in stride and while not exactly brushing them off, accepting that central banks can’t do anything much about supply-chain drive inflation but they are going to take action anyway. That makes the upcoming rate hikes (in Canada, for example) illogical. If a policy cannot affect the variable it targets, why use it? Ah, because government needs to be shown it’s doing something, even if it’s useless. Oh, okay, we have confidence that doing something, even if it’s the wrong something, is right. Got that? The only real problem is that policy has lags in taking effect and by the time supply chains get repaired, totally independently of monetary policy, central banks may have raised rates more than they should. Overshooting, and you never know for 3-9 months that’s what you have.

This is pretty silly but it’s how things work. To some extent, we see traders retreating from the dollar because even though the relative real differential is being targeted to be the highest, it might be excessive, while the others are catching up. Let’s bet on those instead of the leader. Japan is an example. The economy is not as bad off as feared only a month ago. There is practically a zero chance of a rate hike or even a hawkish tone, and clearly the real return divergence can only grow–so why was the yen in a favored position (until today)?

Relative real returns matter. They are not fully determinative but the top factor in FX pricing, followed closely by policy credibility and economic robustness. The dollar wins on all fronts. It’s fun to try to figure out why the dollar retreats sometimes in this crystal-clear situation, but in the end, those reasons have to do with crowd psychology and not economics or even history. Stay the course.

Do Not Deduce Dept: Savings fell to the lowest since 2008 as consumers kept on spending. This is mildly interesting–it implies confidence in the future. But that’s about all you can deduce. You shouldn’t heed anguished cries that the consumer will stop dead in his tracks because he ran out of money. After all, this is America. We have credit cards.

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