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“24 hours in a day, 24 beers in a case. Coincidence? I think not.”

H. L. Mencken

Commentary & Analysis

Yellen wolf? And betting on Bligh?

I read an interesting article on concerning the performance at PIMCO now that Bill “Captain Bligh” Gross has left the ship. According to the author, the new team now at the wheel has outperformed their old leader by concentrating its bets on the middle of the yield curve, under the expectation the Fed will indeed do the dirty deed—hike rates in June. But the old captain, now at the helm at Janus (not yet rearranging the deck chairs), has positioned into longer term maturities expecting the Fed to stand pat for longer than now expected.

Let’s face it, we don’t know what the Federal Open Market Committee will say tomorrow, though I suspect at least 34.245 trillion man-hours will be wasted guessing, 23 million trees will lose their life for research report writers musing, and at least 23 analysts will show up on CNBC and Bloomberg TV after the fact to say, “I told you so.”

Before I get into my guesses, I want to share a couple of paragraphs from some people who have been more right on bonds over the last 10-years, or more, than anyone; even better than Bligh [my emphasis].

The downward pressure on global economic growth rates will remain in place in 2015. Therefore record low inflation and interest rates will continue to be made around the world in the new year, as governments utilize policies to spur growth at the expense of other regions. The U.S. will not escape these forces of deflationary commodity prices, a worsening trade balance and other foreign government actions.

U.S. nominal GDP in this economic expansion since 2008 has experienced the longest period of slow growth of any recovery since WWII. Typical of the disappointing expansion, the fourth quarter to fourth quarter growth rate slowed from 4.6% in 2013 to 3.8% in 2014. A further slowing of nominal economic growth to around 3% will occur over the four quarters of 2015. The CPI will subside from the 0.8% level for the period December 2013 to December 2014, registering only a minimal positive change for 2015. Conditions will be sufficiently lackluster that the Federal Reserve will have little choice in their overused bag of tricks but to stand pat and watch their previous mistakes filter through to worsening economic conditions. Interest rates will of course be volatile during the year as expectations shift, yet the low inflationary environment will bring about new lows in yields in 2015 in the intermediate- and long-term maturities of U.S. Treasury securities.

Van R. Hoisington

Lacy H. Hunt, Ph.D

Hoisington Economic Research

January 2015

Note the date this was penned—January 2015, as it was Hoisington’s fourth quarter of 2014 summary. They have been dead on the money so far this year as yields have fallen sharply around the globe and US growth is decelerating based on the latest series of economic data I have seen over the past few weeks.

One wonders why Bill Gross continues to play the game given his awesome wealth, excellent reputation (given the body of his work over time), and age. Besides ego gratification the only answer is that he really loves this stuff. And if he loves this stuff and remains focused and now has something to prove to boot, betting against him over time may not be a high probability trade.

So, the stage is set: Could it be that Bligh will rise up and crush the Young Turks once again?

So what does this have to do with US dollar? I suspect if the FOMC shows its antediluvian dovish face once again, the US dollar could stage a significant correction lower triggered by a back-up in benchmark yield spreads. I have included the 2-yr spread versus FX rates in a few of the major pairs below. One thing that stands out is how closely the move in the spread has been correlated with the move in FX rates.

2-year Benchmark Spread Australia – United States vs. AUD/USD Weekly:

2-year Benchmark Spread Eurozone – United States vs. EUR/USD Weekly:

2-year Benchmark Spread UK – United States vs. GBP/USD Weekly:

If you don’t remember the Munity on the Bounty story, let me share a salient summary of one aspect from Wikipedia:

After the mutiny aboard Bligh’s ship he “performed an extraordinary feat of seamanship, Bligh navigated the 23-foot (7 m) open launch on a 47-day voyage to Timor in the Dutch East Indies, equipped with a quadrant and pocket watch and without charts or compass. He recorded the distance as 3,618 nautical miles (6,701 km; 4,164 mi). He then returned to Britain and reported the mutiny to the Admiralty on 15 March 1790, 2 years and 11 weeks after his original departure.”

So, let’s not count Mr. Gross out just yet.