We’ve all heard the expression that information can get “priced in” to the value of a particular asset (stock, commodity or currency) but the trick to doing so lies in anticipating what the typical reaction will be. Tuesday’s overnight action was a perfect case in point.
There was a slew of economic data scheduled to be released including the Producer Price Index, Industrial Production and Capacity Utilization rate and each one was expected to improve (or have a higher reading than the previous month).
Until recently, better-than-expected numbers had actually been a negative for the dollar, with the reason being that the market saw the Fed staying on hold. That thinking has apparently changed however because now, positive data is being taken as an indication that the Fed could start normalizing policy faster than previously thought.
This thinking is being reflected in the bond market, with the yield curve steepening to multi-decade highs. The 2 year note, most sensitive to expectations regarding the Fed, closed at 0.85% on Monday and is now 60 basis points above the Fed’s upper limit on the overnight rate. Traders in Fed Funds Futures have already priced in about a 50/50 chance to see overnight borrowing costs rise to 50 basis points by June.
A string of stronger-than-expected economic reports provoked several analysts to revise up their projections for fourth quarter gross domestic product. The reports show that businesses are rebuilding inventories at a faster pace than many economists thought, consumer spending has been firmer than expected and the U.S. trade deficit narrowed. GDP expanded at a 2.8% annual rate in the third quarter. Now it looks like it’s going at a fast pace in the fourth quarter. If it’s sustained, that could help to bring down the unemployment rate. Here’s a sampling of revisions we’ve picked up so far for the Q4 growth rate:
What this implies is that from this point, economic news which points to a continued recovery is likely to be positive for the dollar as traders continue to bet that the Fed will normalize policy ahead of the ECB and BoE. The way to get ahead of this is to use the information to your advantage.
On days when reports are expected to improve from the previous month, look for the USD to gain in overnight trading as traders “price in” the idea of the Fed raising rates. And if the data proves the expectations to be correct, exit the position as trader’s book profits. It’s the latecomers that tend to get burned while those who can anticipate reap the rewards.