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Will Currency Interactions be Inflationary or Deflationary?

A consistent theme of these remarks is to expect the unexpected and the velocity of change.

Reflecting upon April, oil had its best month since 2009 up about 21%.  Since its mid-March multiyear lows, crude has advanced approximately 30%.  Bloomberg writes the number one performing asset class for 2015 is oil/natural gas high yield bonds.  Most of the return has occurred since March 18, the day crude traded under $46/barrel.

Thirty days ago the consensus view was that oil will not trade higher than $50 barrel for a myriad of well-known reasons.  Last night oil closed at $59.58.

And then there is the dollar.  Bloomberg writes we are currently experiencing a once in generation advance in the Greenback citing that there was only one other time since WWII  the dollar has staged such a dramatic upside advance.  I must write, however, April was the first month since June that the Bloomberg Dollar Spot Index declined after rising to the highest level since data going back to 2005.

In my view both oil and dollar can be pivotal in suggesting what may happen in the next 60-90 days.

First quarter GDP has clearly demonstrated the rising dollar has impacted the economy.  All must remember trade is a zero sum game…taking production from one region/country and transferring it to another.  Twenty one countries now have negative interest rates, negative interest rates that are essentially currency devaluations.

Will currency interactions be inflationary or deflationary??

Speaking of inflation, what impact will the 30% gain in oil have in the general economy?

Yesterday the all-inclusive first quarter Employment Cost Index was released. In my view this is the best proxy in determining if wage/cost push inflation is present as both wages and benefit costs are calculated in the index.

Private wages, which excludes government workers, rose 2.8%, the largest gain since the third quarter 2008.  The inclusive ECI that includes government workers also posted the largest gain since 3Q08.

Additionally, applications for unemployment benefits fell to the lowest level last week in 15 years.

It is widely accepted a change in monetary policy might not occur until September.  The narrative surrounding negative European interest rates is rising.  At one point yesterday, the 10 year treasury had increased about 20 basis points in yield in two weeks.  The thirty year Treasury had increased almost 30 basis points in yield during the same period.

This increase in rates has occurred on disappointing data.

Is the bond market suggesting the Federal Reserve is falling behind the proverbial curve?  Will a relflationary narrative become dominant if commodities and wages continue to increase at the current pace in today’s zero rate environment?

If so, how will equities respond?

As noted many times, the markets have become overly influenced by ETFs and indexing, where many are chasing returns via passively indexing.  If it were only this easy.

What will be the headlines on June 15?  I think few suggested today’s headlines 45 days ago.

Last night the foreign markets were up.  London was up 0.13%, Paris up 0.14% and Frankfurt up 0.05%.  Japan was up 0.06%and Hang Sang down 0.94%.

The Dow should open moderately higher on the belief that the manufacturing sector has rebounded for the first time in six months. The thirty year is down about a point and the yield on the 10-year is up about 5 bps from last night’s close in anticipation the ISM has rebounded from the slowest growth since May 2013.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.