Market sensing Gary Cohn as the new head of Federal Reserve

When it comes to US monetary policy settings, the market is increasing of the belief that National Economic Council director, Gary Cohn, will be the Chair of the Federal Reserve (Fed) from March 2018.

US Federal Reserve
Source: Bloomberg

Therefore, traders see the US central bank under the command of a man who simply has to appeal to Trump’s vision of an ultra-accommodative Fed. However, at the same time, likely to unwind a number of regulatory initiatives put in place during Janet Yellen’s tenure. The cynics even making the claim that Janet Yellen’s Friday speech at Jackson Hole, in which she defended her regulatory achievements, were directly aimed at Gary Cohn, who could unwind some of these actions and were almost seen as a farewell speech.

So traders are thinking about the financial landscape with a man whose vision on monetary policy is actually little known to market participants. We suspect he is going to be uber-dovish, therefore the combination of US fiscal and monetary policy being driven by a Trump/Cohn partnership is keeping USD bears from closing what is in effect the largest net short position held on the USD since 2013.

We can throw in five consecutive downside misses to US CPI (ex-food and energy), with a progressive view that the US government could exhaust all extraordinary funds by 13 October, amid a continued anti-globalist stance on trade. The result, of course, is a strong bull flattening of the yield curve, falling ‘real’ yields and a USD, which  has dropped close to 11% in 2017 and trading at the lowest level since May 2016.

Amid these ever changing dynamics, we can see the interest rate markets pricing a 37% chance of a third rate hike by December and a mere 40 basis point (or a 60% chance) of two hikes priced through to 2020. This stood at 53 basis points a month ago, so you can see the repricing of interest rate expectations, is, in turn, is weighing on the USD.

The question then we have to ask is what will cause interest rate expectations to move materially higher, in turn causing bond yields to sell-off, putting an end to the rampant USD selling. It simply has to come from inflation and inflation expectations moving higher from here. However, the prospect, Trump and Cohn at the helm, driving the US economy, buying USD’s and selling US treasuries is a trade the market isn’t likely to want to put on with any real conviction.

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