Last week's congressional testimony from Federal Reserve Chairperson Janet Yellen has led to a debate among market participants about whether her comments were "hawkish" or "dovish" and when interest rates will rise. My take on the testimony is that the Fed is trying to be both hawkish and dovish at the same time in order to create the most flexibility for future policy action. Given the level of growth and inflation, having this flexibility going forward will be important. With current global economic and geopolitical events, the Fed must be data- and event-dependent as it looks to reduce monetary accommodation. Yellen also spent time during her testimony to prepare the market for the removal of the "patience" language from the Fed minutes, saying that a rate hike two meetings after the removal was not a given. This flexibility will likely lead to increased volatility in the markets in the short term as each data point will be analyzed and interpreted closely.
Last week's Gross Domestic Product (GDP) report reduced the preliminary estimate of fourth quarter growth from 2.6% to 2.2%. While overall growth was revised lower, last quarter's consumer spending report climbed by the most in four years, which continues to support the strength of the economic expansion.
I was asked last week to provide some additional detail around why we expect a strong dollar and oil prices to remain in a range of roughly $40 to $60. With regard to oil, we believe that we currently have significant supply/demand imbalances today, which have driven prices lower. This imbalance is due to an excess supply and not a decrease in demand. We believe the supply imbalance will moderate in the next 12 to 18 months due to the drop in capital spending and the more rapid reduction in oil well productivity for wells that are using fracking methods.
We believe the U.S. dollar will be well-bid because the rest of the world is trying to stimulate growth, either by lowering interest rates or through quantitative easing. This comes at the same time that the Fed may increase interest rates, making the U.S. dollar more attractive on both an absolute and relative value basis. The world is actually short dollars because of the roughly $4 trillion of debt issued in dollars by non-U.S. entities. The current strength of the U.S. dollar adds additional pressure to cover some of this exposure, which requires buying U.S. dollars.
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