Stocks and the Weak Dollar

The stock market should continue to rally over the next 2-3 weeks, as corporate earnings releases stay strong and the Fed keeps rates steady and maintains its gradual stance to tightening at next week's FOMC meeting.  A cautious pullback in stocks ahead of the Wednesday rate announcement can't be ruled out.  But, more significantly, the rally may very well pause when the corporate earnings season ends in late February, as the market focus shifts to the Fed.

The biggest threat to the rally at this point is the weakening US dollar and what it might mean for the Fed -- will it tighten more aggressively, similarly to what happened in 1987 (see my blogs of January 8, 2018 and December 26, 2017).  Although it is probably too soon and too orderly a decline so far for the weak dollar to end the stock market rally, developments in the FX market need to be watched carefully.  

A major driver of the dollar weakness is probably the widening trade deficit.  This trend should
continue, thanks to higher-priced oil imports and increased demand for imports as the tax cuts boost spending.  This means that dollar weakness will persist.  And, the monthly trade deficit will get increasing attention from the markets.

Dollar weakness will be a serious problem for the stock market if Washington officials -- either the Treasury or Fed -- say it's a problem.  Last week's stock market's sharp reactions to Treasury Secretary Mnuchin's negative-dollar comments and Trump's subsequent positive comment illustrate the importance of the official dollar view for stocks. 

The Fed will not likely mention the dollar in next Wednesday's FOMC Statement.  FX developments are the purview of the Treasury not the Fed.  And, the impacts of the dollar weakness on the real economy and inflation, the purview of the Fed, are not yet noticeable enough to warrant comment.  Indeed, the Statement should not change its description of the economic outlook significantly, since last week's sub-3.0% Q417 Real GDP means the Fed does not have to change its overall economic outlook.  Discussion of the weaker dollar, as well as the related easing in financial market conditions, will probably be seen in the Minutes of next week's FOMC Meeting, due in a few weeks.  It could get the market's attention.  Note that if dollar weakness eventually becomes serious enough to warrant an official reaction, coordinated FX intervention rather than a rate hike could be an option.

Next week's key US economic data are not likely to have a major impact on the markets.  The January Mfg ISM is likely to come off a bit from its high December print, as have most other manufacturing surveys released so far.   Consensus looks for a speedup to a near-trend 180k m/m increase in January Payrolls.  (Payrolls averaged 171k m/m in 2017.)  Evidence is mixed.   Some large retailers closed many stores this month, but seasonals look to offset a lot of post-holiday layoffs.  Heavy snow in the Northeast could have boosted ski resort jobs.  Calendar considerations point to a modest 0.1% m/m increase in Average Hourly Earnings -- and the y/y would fall to 2.4% from 2.5%.