Lower Rates, Higher Dollar? Welcome to Trade Ideas. I'm Jake Merl sitting down with Joseph Trevisani of Fxstreet. Joseph, great to have back on the show. Thanks for having me. So today, we're going to be talking about the Fed. We just have Paul give his testimony and we also, at the end of the month, have the FOMC meeting where there might cut rates. Correct. So we wanted to get your view of Paul's testimony and how you see Monetary Policy affecting markets in the weeks and months to come. The Fed is in a very interesting position I think. They are considering a raid move quite seriously. In fact they have set it up so with their devotion to transparency. They don't really have a lot of choice. The markets have fully priced it in. So it's something that they need to do. The Fed is not going to want to create the kind of market repositioning that will happen if they don't cut rates at the end of the month. On the other hand, they don't have a very strong economic rationale. At least not one based in the United States. Traditionally, if you have an economy that's growing somewhere between two and three percent that seems to and steady and stable at that level, you really wouldn't consider cutting rates. If you have inflation running somewhere between one and a half and 2.1, 2.2 percent, you also wouldn't normally consider cutting rates. If you have very hot job market, which we do, yet there's really not overriding wage inflation, you wouldn't consider cutting rates. But the Fed is going to do this. So we have to look and I think they found a, not maybe not more acceptable, but a good economic rationale. Almost a socioeconomic rationale. What was Mr Paul said was that the wages were not growing really fast enough to support inflation. To drive inflation higher and that's correct. However, wages are improving at a better rate than they have and also disposable income at the best rate they have since the recession. I think that's the focus because if the expansion slows down or stops or goes into a recession or a mild recession, you will lose all of that wage pressure. As he said a number of times, that wage pressure is benefiting classes in society that had been left out for many years and it has a farther reach than it has before meaning to people who had not been employed or marginally employed. So those are rather large social and economic benefits. Once they fit exactly in the Fed's mandate from congress for full employment. So I think the focus on that to keep the expansion going, in effect to take out an insurance policy on the expansion is what the Fed is aiming at and I'm pretty sure they'll do it. But do you think rising wages will directly translate into rising inflation? Well that's the another interesting thing. One of the and I think the House testimony, Congresswoman from New York, Ms. Casio Cortes, brought up the Phillips curve, which is a very accurate question. Surprisingly enough, I suppose politically at least Larry Kudlow, the President's economic adviser, praised her for it. The idea is one which seems logical. Phillips Curve dates from the 1950's late 50's early 60's and it postulates that rising employment, a tighter labor market falling unemployment will naturally enough force employers to offer higher wages. This translates over time into inflation. Both wage inflation and then cost price inflation. It has a seductive logic to it. It seemed kind of make sense. It hasn't really worked out terribly well empirically. But now because and the environment, the global environment that you're in in the 1950's and 1960's really did not have a great deal of offshoring. People didn't move their factories to Malaysia or to Indonesia or to China. So the logic was at least domestic. Now, the global market means there's also a global competition for wages and global competition for labor. So one of the great puzzles, well it's actually not a puzzle but from Fed policy point of view which is based on monetary policy, you increase the money supply you get inflation, hasn't worked. If you look at the inflation records since the recession and the amount of money that was pumped into the economy through lower rates and also through kind of quantitative easing, got very little inflation. The link however, it was functioning in the past and now almost completely broken. So that was her point. So I think that is true. So the Fed can lower rates which will give a boost, a benefit of support to the economy without worrying a great deal about inflation. I think that was both of their points surprisingly in agreement. So you think at the upcoming meeting in July where you get a 25 beep score. I think we will. You know if they're going to take out an insurance policy, it's almost more of a psychological insurance of policy for business. Consumer spending has held up, reason well it dipped and then it's come back. Business spending and business sentiment, which is one of the underpinnings of the economy, has not. It has fallen and stayed relatively low. I think businesses are a lot more worried about the global economy and about China and perhaps about Brexit. Maybe they're going to like Boris Johnson. I don't know. I don't see that but you never know. Then consumers are. The consumers are looking at low unemployment, ease of getting jobs, more jobs than there are people to fill them and rising wages and low inflation. So from a consumer point of view, what's not to like. So but it's the businesses that are more concerned. So in a way I think this will do more perhaps for the psychology of business because after all, a 25 percent interest rate cut and the fed funds rate is really not going to do very much as far as driving greater growth. But it might drive some sentiment which in turn could provide some more business spending. So bringing this back to trading and investing, how do you see this all impacting markets and specifically the US dollar over the weeks and months to come? The traditional view and two weeks ago, a little more the dollar took a dip when this became more credible. I mean it's been incredible for while. The Fed funds futures have been at a 100 percent, that's a volatile measure but nonetheless it's been at a 100 percent for probably two months maybe more. I'm not sure about that. They're going to reduce at least by quarter. So the dollar of course lower rates to that. In addition, the treasury rates have been coming off since early November. The treasury rates started to fall six weeks before the Fed raised rates the last time in December. They raised I think on the 19th of December. Trivia rates have been falling since the 8th or 9th of November. I mean the credit markets had a very different view than what the Fed actually did. So that of course has an impact on the dollar. Through out all of that, the dollar has held up reasonably well and in fact it popped over 1.13 to the Euro last week announced back underneath. What's going on of course, are two-fold. One, if the Fed is worried about the global economy, so is everybody else. So if the Fed is going to start lowering rates, so is everybody else. The only people who were being resistant right now are the Canadians. They also have a very strong economy and a very strong labor economy, surprisingly strong. They just set an all-time record I think for the number of jobs created in one months, two months ago. Why? But it's a very impressive feat. So one, you're going to get the other central banks looking at, and Mario Draghi has said this, he's headed to retirement and he's probably going to get another really nice job too. Christine Lagarde is going to take his position, another very nice job. So the other central banks are going to come with the same analysis and then come to the same reason for doing the low rate. The Australians and the New Zealanders have already done this. In addition, all of the trading currencies that trade against the dollar, don't really want their currencies to revalue, to go higher appreciably against the dollar. So there's that pressure as well. So it's a race to the bottom. Exactly. So the standard thing it's what usually happens. There used to get 25-30 years ago divergences in rate policy between major central banks. You don't really get that anymore. Much as the labor market has become not quite a global Phillips curve, but it's tending in that direction or at least a global market. American workers really do compete against workers in Vietnam and against workers in China and Indonesia. It's the same thing with bank rates. They are very much in line when someone starts moving. Especially when it's the Fed because the Fed being the world's largest. Having the most impact in a basis of the world's largest economy. So you're saying even though the Fed is about to cut rates, that the dollar should actually stabilize or strengthen from here? I think it probably will. Because what we're seeing here, are two things. One, the US economy is doodling better tan everybody else. Two, the Fed rate cut at the end of this month if it happens. It's fully priced in. Everything is known about this, everybody has talked about it, everybody's priced it in for months now. Some of the other major central banks, primarily ECB, has recently started talking about it but there's no move. Mario Draghi said I believe that they could lower rates, well they can't actually lower rates because they're already at zero. But they can certainly start up their quantity and buy more bonds. They can do whatever they were doing in the past. So but that's not at the operational level yet that they're not actually contemplating it. When that becomes something that is looming in effect, then of course that's a new factor in the economy, a new factor in the currency equation and it would play to the dollar strength. It would lower the Euro. So that's why I think it's still possible. So how much upside do you see for the dollar or how much downside do you see for the euro? Well that's a little difficult. We're about 112.5 right now in the Euro. I'm still looking between 105 and 107 by the end of the year. I still think that's something that given the current and the trends that we're seeing both as far as the central bank rates go and the world economy, something that seems likely. What would be the biggest risk that this is? The biggest risk is that the Fed gets more worried than they are and you get a move to more than one way. I mean I think what you're going to get right now is 125 basis point cut in the end of this month on the 31st. Then I think they're going to move back to a pause, a neutral and see what happens. If that is not the case, if the China trade issue becomes more volatile and more acrimonious and you have more terrorists on both sides, that'll be a risk for that because the federal undoubtedly respond to that by reducing rates against. So just in case things don't go your way, would you have a stop-loss and not trade for the Euro? Yes. I would put it about 115. Because if you get to that point and there has been a serious alteration in the underlying economics and the underlying rate policy, something is changed. Because if you look at that the currency charts, there are pretty much wandering around and have been for more than six months in a very tight range. The basics haven't changed. The fundamentals, things that drive long-term trends in currencies and in markets as well haven't really changed. You know that, just look at the charts. So if you get to 115, things have changed. Well Joseph, that was great. We'll see how it plays out in the months to come. Thanks so much for joining us. Thank you very much for having me here. So Joseph is bearish on the Euro. Specifically, he likes shorting it at current levels with a stop-loss at 115 and a target between 105 and 107 by the end of the year. That was Joseph Trevisani of Fxstreet and for Real Vision, I'm Jake Merl