Is now Bullard the hero of the “sane and reasonable” crowd?

Outlook: The data today is housing starts and permits, never inspiring in FX. A couple of other things are holding attention. St. Louis Fed Bullard said the FOMC shouldn’t rule out rate increases of 75 basis points. This seems to be a generality and not a call to arms for 75 bp in May, but is still a shocker.

Secondly, the dollar/yen has zoomed past the previous high (125.86 from June 2015) and is now at the highest since April 2002, literally 20 years ago. The all time high on our eSignal data base is 135.16 from December 2001. The much longer Reuters data base remind us that the dollar/yen was 250-300 during the 1980’s and broke below 200 around 1985. See the chart. Various Japanese officials, including FinMin Suzuki, have been muttering about a too-weak yen as destabilizing, etc., leading to some muted chatter about intervention. Overnight he said “the Japanese currency was weakening rapidly and indicated that the impact of the moves could be harmful for the economy,” according to Bloomberg.

“We are monitoring moves in the foreign exchange market with a strong sense of vigilance.” Language that includes “watching carefully” is language that usually precedes intervention—but the day before, he had said “the market determines the FX rate.” Suzuki will join G7 and G20 in Washington tomorrow and will also hold separate meetings with the US.

There is a hint that he may talk to TreasSec Yellen about the yen, a cousin to asking permission to intervene and perhaps inviting the US to join, but we doubt it. The last time we had coordinated intervention was when the yen crashed following Fukushima and before that, April 1998. But today what we have is not a crisis—it’s policy divergence. It would be a wild departure for Yellen to have anything to do (or say) about intervention when the solution to “the problem” is obvious. And is it really a problem? There is a small element of “don’t throw me in the briar batch, Br’er Fox.” After all, Japan has a trade deficit in goods, for which a weaker yen can only be good, even if it messes up corporate planning, as BoJ Gov Kuroda complains.

Bloomberg credits the Bullard comments about 75 bp as the trigger for this latest runup, which may be true but not useful. The trend was formed when the Fed dropped “transitory” inflation and started loudly favoring big hikes and at the same time, Japan affirmed it’s sticking to curve control and intervened modestly to hold the 10-year JGB under 0.25%. We seldom see such a textbook-perfect case of policy divergence driving a currency. Bloomberg also says today is “the 13th day of yen falls against the dollar, the longest run of losses in Bloomberg data starting in 1971.” Again, perhaps true but definitely not useful.

The most interesting thing of all is Fed Bullard speaking realistically about the neutral rate, which some point out implies a return of the Taylor Rule. The Taylor Rule got back-burnered during QE, but some adherents have been saying all along it’s the right idea that we should not be neglecting. Wikipedia has an excellent summary, by the way. More than one generation of economics students and countless Fed researchers have written about the Taylor Rule, which has multiple variations, including soft and hard versions.

But the essence is that when inflation goes up by 1%, the Fed should raise the nominal interest rate by more than 1% in order to keep the real rate positive. Considering the number of hikes now contemplated for this year, we will end the year just under a positive real rate. And that’s assuming two hikes of 50 bp each and no increase in inflation. Bullard said the Fed should get rates to 3.5% by year-end and thence to a neutral rate of about 2.4% “expeditiously.” And oh, yes, talk of recession is premature.

The return of the Taylor Rule is a welcome development to reality-checkers and a headache for the Fed, which is going to have a devil of a time with QT. But Bullard is now the hero of the “sane and reasonable” crowd.

If we assume Bullard is right—again—the US may be on the path to normalizing the vast divide between financial conditions and the real economy. It can’t possibly go smoothly but removing government interference in markets is generally a Good Thing from the point of view of properly determined prices. (It can be a bad thing from a fairness or humanitarian point of view.)

So, while bond yields in other places are rising alongside the US but lacking this much clarity, notably the ECB, the US is the leader, so to speak, even if it was others who technically raised rates first. This can only benefit the dollar, if not in a straight line.

Foreign Affairs: Russia continues to display tactical incompetence but had a strategic shift with the shelling of the western haven of Lviv. Zelinsky says it’s going after Donbas in a big way as a new phase and looks like levelling it. A number of commentators say the US can legally expropriate the $100 billion or so of Russian money in US banks, either by executive order or an act of Congress, depending on source, because of war crimes.  

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