Assuming the recession fear turns into panic

Outlook: We get May industrial production and the leading indicators today, with IPI the biggie because everyone has his knives sharpened for any sign of pullback. We are likely to get it, too, April had a nice gain of 1.1% but the current forecast for May is a drop to a measly 0.4% and of the total, manufacturing down to 0.3% from 0.8%.

Notice these are still positive numbers, but critics already plan to carve the data like a chicken. Try to avoid reading the sky-is-falling stuff. The WSJ has a headline and sub head saying “Three-quarters of global CEOs say we are in a recession or will be in the next 12 to 18 months, according to a new survey.” Notice that the Atlanta Fed GDPNow is still at zero for growth in Q2.

This is the old cognitive game of getting what you expect and seeing what you already expected to see. It’s a common mental issue most explored by Nobel winner Daniel Kahneman and colleagues, most recently in the book Noise. It’s important to note that Kahneman won the Nobel for economics even though most would think he’s a psychologist or something. No, economics is about behavior, and one of the most compelling observations is that economic theory is bunk when it projects that each person seeks to maximize self-interest. That’s not what they are doing at all.

Anyway, we are about to get a flood of data like industrial production, the so-called high-frequency stuff, that can easily be colored to “prove” recession is coming. Be careful about buying into. It’s probably correct, but at some probability level that is far from certainty.

Another seeming inexplicable event is the Swiss National Bank and all its doings. Any newcomer to FX would be befuddled by the intervention story today. In the olden days, when a central bank wanted its home currency to stop falling, it called up a couple of bank treasurers and ordered them to buy the stuff and pay for it with other currencies in the central banks’ account or on credit.

A central bank may choose to intervene to (1) punish an unruly trader (2) limit inflation arising from devaluation and/or (3) restore the sense of managerial competence and central bank reputation. And because the central bank warned the instruments of intervention ahead of time, meaning those bank treasurers, some of them could not resist giving a wink and nod to the chief dealer, which made the eventual intervention seem lesser and thus more effective.

We saw this repeatedly pre-euro from the UK, France, Belgium, Netherlands–and Japan, the champion intervener of all time. Remember 1994 and Soros’ challenging ineffective BoE intervention, ineffective because the structural basris was wrong. We saw it from the US, too, on its own behalf and others’. It was awful. We don’t miss those days at all, not having a good build-in lie detector.

Then along came the Swiss National Bank, which liked the idea of their currency being the ultimate safe haven (this was before the money laundering and tax evasion scandals), but didn’t like it being too-strong, especially against the euro, damaging exports and making the Swiss pay $8 for a Coke that cost $3 just across the border in France. The SNB adopted an anti-appreciation policy and set it loose among the pigeons in March 2009, moving the EUR/CHF a good 500 points in a few hours. Professional and retail traders lost a bundle, brokers went under, including the arrogant Refco, and Oanda made a permananet name for itself by compensating its customers whom the SNB had just screwed. It’s a never-before seen management decision and the reason we recommend Oanda to this day.

Then somewhere along the way the SNB shifted from actual FX market trades to managing daily and intraday liquidity. It’s a sign of Swiss pride that the SNB website has a chronicle of monetary events. It’s pretty interesting, too ( https://www.snb.ch/en/iabout/s...). Here the Swiss FX market intervention story gets murky to us. The original idea was to prevent the Swiss franc from appreciating overly vs. the euro as well as the dollar, and to use real money to do it. Then the methodology changed to using the daily reference rate as the intervention key. Gittler at BDSwiss followed it meticulously and is probably the only guy on earth outside the SNB who knew what they were doing. Now the new message is to intervene if the Swissie weakens–the opposite of the earlier direction.

Everyone is making much of the Swiss daily rate having just been shifted from -0.75% to -0.25% and the promise of more to come. This means, probably, the SNB is really scared of inflation. But should we be looking at daily rates when it’s the future that counts for the currency?

Swiss inflation is 2.9% y/y as of May, and with a positive yield at 1.48% for the 10-year, the negative real return is only 1.42%. In the US, it’s more like 3.3307% minus 8.6% = -5.27%. Not only is the Swissie a safe haven, it’s better than the dollar for real yield, not to mention the euro (1.703% - 8.1% = -6.4%).

These are current numbers, not expected ones, but never mind. The Swiss franc is TOO attractive. The SNB is going to be fending them off with sticks. Since it had been using the daily reference rate for intervention purposes (including messaging), what does it use to intervene now? Real money? And if it’s looking to prevent weakness, not strength, doesn’t that buttress the more-hikes narrative?

We have been following this market and its close relatives for decades but we fail to understand what the SNB is doing and why and where it will lead. It’s one reason to love FX–you think you have it figured out and it punches you in the nose.

For today, we await comments at a conference by Fed chief Powell and hope that he repeats recession is not inevitable (since nobody believes Biden when he says it). Assuming the recession fear turns into panic, the dollar gains on the safe haven aspect of things next week. If recession fear recedes, we can get more interest in riskier stuff like the AUD, again, currently the plaything of the risk averse vs. risk embracers. The CAD is still a bit mysterious; those who understands swaps say the BoC will hike by 75 bp at the next meeting (July 13) but if so, why is the CAD not stronger?

Bask in not knowing stuff. It’s a gift.

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This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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