While the case for more QE in the UK has weakened, we could get a statement from the BOE, such that will provide us with the new governor’s way of thinking, says Simon Smith of FxPro. Mark Carney cut the rates on his first meeting as the head of the Bank of Canada.
In the interview below, Smith discusses the fine balancing act of the Fed, the potential for more rate cuts from the ECB, the Chinese credit situation and volatility in the summer. We could see exaggerated moves.
Simon has over seventeen years experience of macro forecasting and investment strategy research. Prior to joining FxPro in May 2010, Simon was a consultant with Thomson Reuters, having spent four years as Chief Economist at Weavering Capital. He has held economic and strategy positions with Standard & Poor’s, together with consultancy firms 4Cast and MMS International. Simon holds an MSc. in Economics from the University of London and a BSc. from Brunel University.
- After the market’s reaction to Bernanke, we have seen Fed officials making efforts to “clarify” the message and calm the markets. Can the Fed convince the markets that tapering QE is not a done deal but rather depends on the state of the economy?
I’m not sure it’s as simple as that. In my view, I think the markets did over-react, but you can just as easily ascribe that to the complacency being displayed earlier in the year, when stocks and most other assets appeared to be rising despite, rather than because of the prevailing economic data. The Fed were pretty clear in their statement of the conditionality attached to any ‘tapering’ of asset purchases. It’s a balance between preparing markets for the inevitable and not scarring them. Investors often refer to the 1994 episode as the example of what can happen if the market do run scared, when 10 year yields rose 200bp over the course of the year, 2 year yields rising 350bp and they are very keen to be as open as possible on what is driving their thinking.
- With the rise in yields of peripheral countries, can we expect Draghi to put the negative deposit rate on the top of the agenda or even announce new policy measures?
I’m not sure we are quite at that stage yet. He certainly appears to have warmed to the idea in comparison to the sentiment expressed earlier this year. It’s a question of balancing the downside risks against the perceived benefits of such a move. In ‘normal’ times, the deposit rate was 1% below the ECB’s main refinancing rate, so offering an incentive for banks to lend money in the market, rather than park funds overnight at the ECB late in the day. But if the ECB were to cut rates again, the difference would be merely 25bp. I can see it happening in the next 1-2 months, but the issue is that not all of the ECB voting members are on board with the idea.
- Expectations from BOE governor Mark Carney are high. With inflation refusing to fall in the UK, what can Carney do? Will he present new measures already on his first meeting?
Be on your guard. After all, he cut rates at his first meeting in charge of the Bank of Canada. Having said that, I would be surprised to see further quantitative easing this week, not least because there 6 members of the MPC to be convinced (2 current members have been voting for it in recent months, plus King). However, it could well be that we get a statement from the Bank, which normally is not the case when rates are on hold (there have been a small handful of exceptions to this rule). This could be the first insight into his thinking. In general, the case for more QE has weakened in recent months, so I don’t yet see it as a done deal in the UK.
- The Chinese credit crunch added fuel to the markets’ fire. Is this crisis already behind us, or can it still take its toll on the Australian dollar or have an impact elsewhere in the world?
There is a fairly strong seasonal pattern to rates in China around mid-year and this suggests it could be several more weeks until rates normalise. Beyond that, there is clearly a wider issue in play. Lending has expanded strongly in recent years, partly as China has countered the strong headwinds being seen elsewhere in the world, which allowed China to push ahead during the worst of the credit crisis. One thing we should have learnt over recent years is that a credit crisis lasts far longer than nearly everyone expects. The issue in China is that much of this lending has occurred beyond the normal banking system, making it much more difficult to track and deal with. The outlook for the Aussie remains lower, in part owing to the on-going issues in China, but also because the RBA seems quite content to see it move lower, judging by the latest post-meeting statement.
5. It’s summertime in the northern hemisphere, a time when trading normally slows down. Will we have a normal summer this time? Or will the tapering speculation or perhaps a Greek crisis keep markets busier than usual?
In general, volumes are likely to be lower, but the interesting thing is that volatility (as measure by VIX or DB’s CVIX indices) has risen on average during the previous 4 years over the summer period (between mid-July and mid-August). This was the tendency pre-crisis, but the extent of it has been more pronounced since. This has more been down to the fact that events have triggered greater volatility, such as the Greek crisis in 2010, the debt ceiling issue in 2011, renewed Eurozone fears in 2012. So volatility is likely to nudge higher and there are plenty of potential risk events that could exaggerate this tendency.