Bank of England – Trick rather than treat

The Bank of England (BoE) hiked rates 25bp yesterday for the first time in a decade, as expected, with recent domestic and global macro data seemingly helping the Monetary Policy Council inch over the rate-hiking start line.

But that was not real story, with financial markets always likely to look beyond the headline decision and focus instead on the underlying message.

Markets’ dovish reaction in the past 24 hours suggests that they zeroed in on BoE Governor Carney’s view that future rate hikes would be gradual and limited.

The Sterling Nominal Effective Exchange Rate is down 1.4% to the bottom of a 5-week range and markets are now pricing only a 34% probability of a 25bp hike in February.

Carney’s cautious outlook for the policy rate’s path is in line with my expectations that macro data and the cloak of uncertainty which surrounds Brexit will limit the need and room for the BoE to tighten monetary policy.

Fundamentally, the UK economy remains fragile, with lacklustre GDP growth of only 1% in Q1-Q3 2017 lagging growth in other G7 economies, and the medium-term outlook remains uncertain at best, in my view.

Weak retail sales and household consumption growth of only 0.5% in H1 is clearly acting as a drag on overall economic growth.

A key reason is that growth in economy-wide real earnings has slowed sharply in the past two years, in turn the by-product of slowing growth in employment and real earnings.

Moreover, the household savings rate is an already very low 6% while commercial banks are looking to tighten lending standards and pass on yesterday’s rate hike to borrowers.

With this backdrop and likely slowdown in imported inflation, core and headline CPI-inflation may be close to peaking, in my view, although there is of course the no small-matter of Brexit, a known unknown of considerable magnitude.

Governor Carney’s clear message that the BoE may not need to hike much to get inflation back down to 2% in coming years is somewhat reminiscent of the US Federal Reserve’s policy stance in 2015 and 2016.

It is possible, in my view, that the BoE’s rate hiking cycle could mirror the Fed’s with the BoE only delivering one (or perhaps two) hikes in 2018, in which case markets may need to further reduce their expectations of a February 2018 rate hike.

Read the full article on my website.
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My Top Currency Charts

My macro & FX analysis is premised on both a detailed qualitative assessment of Emerging and G20 fixed income markets and economies and a rigorous quantitative analysis of data, trends, policy decisions and global events too often taken at face-value.

A picture can say a thousand words and a well-constructed and timely chart can shed light on often complex economic and market developments and challenge engrained assumptions.

Ideally, a chart will be forward-looking and a valuable tool in helping forecast economic and market developments and ascertain whether possible market mis-pricing may trigger turning-points or corrections.

There are of course limits to what even the best chart can do, with in particular the line between correlation and causation sometimes blurred. One should also be weary of reading too much into sometimes limited or patchy data sets and underlying data sources can add to or detract from the chart’s credibility.

Moreover, a chart can lose its potency over time, so while on average my research notes include about a dozen charts and tables I am constantly adding new ones.

I have re-published and updated below a small cross-section of the currency-specific charts which continue to play a central part in my narrative and forecasts, including:

  1. Global Nominal Effective Exchange Rates (NEERs)
  2. Euro and government bond yield spreads
  3. Sterling NEER
  4. Sterling NEER and annual pace of appreciation/depreciation
  5. The Renminbi NEER
  6. Renminbi NEER and monthly pace of appreciation/depreciation

I will in coming weeks expand on other notable charts and for a more detailed analysis I would refer you to my previously published (hyperlinked) research notes.

Read the full article on my website.

Uncertainty threatens Euro’s safe-haven status, for now

The Euro Nominal Effective Exchange Rate (NEER) appreciated about 8% between 20th April and late-August and outperformed all major currencies. However, since its multi-year high on 28th August the Euro NEER has weakened an albeit very modest 1%.

The question is whether/when the Euro may again find favour and set new multi-year highs or whether a more acute correction looms.

Part of the answer lies in the confluence of inter-related factors which contributed to the Euro’s steady climb in the first place but have recently lost some traction.

Prior to its take-off in April, the Eurozone NEER had been one of the more stable among the majors. The Euro was perceived as neither a “risk-on” nor “risk-off” currency and the ECB tacitly welcomed the Euro’s underperformance versus its key trading partners’ currencies.

While the French presidential election in April-May was an important catalyst for the Euro’s appreciation, the seeds for its rally and accession to “safe-haven” status had arguably been sown in 2015-2016.

However, some of these Euro-positive factors have become prey to far greater uncertainty and lost traction in recent weeks, undermining the Euro’s relative appeal while the Dollar and Sterling narrative has improved somewhat.

Financial markets have in particular reacted negatively to Sunday’s German federal election and uncertainty it has generated, both at a domestic and European level.

The Euro finds itself at a cross-road and I see little scope for rapid and/or sustained appreciation until the ECB announces the modalities of an extended QE program and a new German government is in place, with the risk biased towards bouts of Euro weakness.

Longer-term, however, a number of factors could drive renewed Euro appreciation, albeit at a likely slower pace than in April-August.

Read the full article on my website.

Asymmetric data and event risk

With the August lull behind us, developed central bank monetary policy has taken centre stage, with the focus in particular on the Fed and Bank of England. Both have signalled that they could deliver a 25bp hike before end-year.

Rates markets have adjusted accordingly and the focus as we enter the last leg of 2017 will be on whether macro data and events support this hawkish turn. Accordingly, I have compiled a comprehensive data and event release calendar for major economies (Figure 1).

Markets now have 17bp of Fed hikes priced in for the remainder of the year versus 7-8bp in early September – in line with my view that pricing was probably too skinny for the liking of a Fed keen to keep its options open while minimising any market fall-out.

Markets are pricing an 80% probability of the BoE hiking its policy rate 25bp to 0.5% at its 2nd November meeting and a further 30bp of hikes for 2018 – a very slow and gradual rate hiking cycle which would mimic the Fed’s tightening in 2015-2016.

The Fed and BoE have cried wolf in the past only to then keep rates on hold. Precedent suggests that a combination of very weak domestic and global macro data and significant Brexit-related setbacks (for the UK) could derail these central banks’ aspirations.

But my twin forecasts of the Fed hiking only twice this year and the BoE only starting to hike in 2018 are clearly at risk. Both central banks have, in my view, set the bar pretty low for a Q4 hike or put differently set the bar quite high to keep rates on hold.

The corollary is that financial markets’ reaction function to forthcoming macro data and events could be asymmetric, with bond yields rising and the Dollar and Sterling strengthening further on the back of good data and/or positive event risk but not reacting as much to weak data and/or negative event shocks.

The Fed confirmed at its policy meeting that it would start as of October reducing its $4.5trn balance sheet. The timeline and timescale, which had been flagged at its June policy meeting, is clearly designed to be slow and gradual in a bid not to spook markets and avoid a repeat of the 2013 tapper-tantrum.

I argued in Paradox of acute uncertainty and strong consensus views (3 January 2017) that “German general elections scheduled for September may well lead to a more divided parliament, making it harder to form a majority coalition government. But it is difficult at this stage to see who will realistically challenge Chancellor Merkel who is striving for a fourth consecutive election victory”. Nine months on and with German federal elections scheduled for Sunday my view has not changed materially.

Read the full article on my website.

Appetite for destruction… and procrastination

Financial markets continue to take into their stride a number of man-made and natural crises and the procrastination of policy-makers in the US, UK and Eurozone.

Global risk appetite remains seemingly well bid despite the still very opaque end-game for rising geopolitical tensions stemming from North Korea and the impact from Hurricanes Harvey and Irma.

In the world of FX, the emerging market carry trade is seemingly enjoying a mini-revival thanks to low yields in developed economies, signs that global GDP growth continues to inch higher and a surge in commodity prices, particularly industrial metals.

Event risk is clearly more acute in September than it was in August but it is not obvious to me that major central banks will deliver the kind of surprises which cause major dislocations in financial markets, including EM currencies.

However, these high-yielding EM currencies’ volatility versus the Dollar remains quite elevated, with perhaps the exception of the Turkish Lira and Indian Rupee.

Chinese policy-makers are seemingly intent, at least for now, on using Renminbi appreciation as a show of strength and I expect further currency gains near-term.

In the UK, the mammoth challenge facing Prime Minister Theresa May is coming into greater focus. Moreover, the Bank of England is unlikely to seriously consider a rate hike before next year, in my view. With this in mind, I see the risk biased toward bouts of Sterling weakness.

The Euro, which eked out small gains versus the Dollar and Sterling following ECB President Draghi’s Q&A session, is ultimately behaving like a safe-haven currency.

I expect the common currency to benefit, not suffer, from lower interest rates for longer and the associated improvement in economic activity even if future Euro appreciation could be modest rather than spectacular.

We know what you did this summer

The month of August has come and gone and I struggle to pinpoint any new, clear-cut common themes. There has been plenty of news and developments for financial markets to digest and react to, including North Korea’s recent missile launch over Japanese airspace, the devastating impact of hurricane Harvey in Texas, the looming US debt ceiling breach, President Trump’s threats of terminating/re-negotiating NAFTA, ongoing Brexit negotiations between the UK and European Union and French President Macron’s announcement of ambitious labour market reforms.

Read ‘We know what you did this summer’ on my website in full.

Broken Records

The past year has been remarkable with political precedents set in the US, UK and France, still record-low central bank policy rates in most developed economies and financial markets and macro data at all-time or multi-year highs (and lows).

The US presidency is fraught with problems but markets turning are a blind eye…for now. The UK is still on course to be first ever member state to leave the European Union come 29th March 2019, at least on paper. French elections have repainted the political landscape and present many opportunities but old (fiscal) hurdles still need to be cleared.

Central bank policy rates remain at record lows in the majority of developed economies, including the Eurozone, UK, Japan, Australia and New Zealand and I expect this to remain the case for the remainder of the year. Loose global monetary policy is likely to continue providing a floor to risky assets, including equities and emerging market currencies.

A number of central banks have hiked 25bp in recent months, including the Fed, BoC and CNB, in line with my year-old view that rate hikes would gradually replace rate cuts. But in aggregate the turnaround in developed central bank monetary policy is proceeding at a glacial pace and I see few reasons why this should change.

The Bank of England has not hiked its policy rate for 526 weeks – a domestic record – and I continue to believe that this stretch will extend into 2018.

In contrast to the Dollar and Sterling, the Euro – by far the most stable major currency in the past seven years – has appreciated over 7% since early April.

While the ECB may want to slow the current rapid pace of Euro appreciation, it is unlikely to stop, let alone reverse, the Euro’s upward path at this stage. For starters, Eurozone growth and labour markets continue to strengthen. The German IFO business climate index hit three consecutive record highs in June-August.

Perhaps the most obvious record which financial markets have broken is the continued climb in US equities to new highs and volatility’s fall to near-record lows.

Emerging market rates continue to edge lower in the face of receding inflationary risks and I see room for further rate cuts, particularly in Brazil given the pace of Real appreciation.

Non-Japan Asian (NJA) currencies continue to broadly tread water, in line with my core view that NJA central banks have little incentive to materially alter their currencies’ paths.

Year-to-date emerging market equities have rallied 24%, twice as fast as the Dow Jones (12%) which has rallied twice as fast as EM currencies versus the Dollar (6%).

Read ‘Broken Records‘ in full on my website.