Inflation? Whatever

Said Carney, Inflation? Whatever
Our mandate requires we endeavor
To help England grow
When it’s apropos
Its fortunate we are quite clever

The pound is higher this morning although I’m not sure I get the rationale. Carney, in his first Quarterly Inflation Report (QIR), explained that the BOE’s inflation mandate was really quite flexible. In other words, he doesn’t really care about it at all. Right now growth is the focus and to that end he promised that until Unemployment falls to 7.0%, the MPC won’t even consider cutting back on QE. And when it reaches that level, they will simply reassess the situation to determine what they think is best at that point. And what of inflation? The fact that it remains well above the 2.0% target and has been there essentially since March, 2006 (with just two blips lower) simply is not relevant in the discussion. As UK GDP has not yet attained its pre-crisis levels, Carney is going all in to insure growth is sustainable going forward. So monetary policy in the UK is going to remain on the ultra-ease setting for many months to come.

At the same time, two Fed speakers yesterday, Lockhart and Evans, both were on the tape saying that the ‘taper’ could begin as soon as September. While Lockhart has been modestly on the hawkish side, Evans is a confirmed dove and to have him agreeing with a reduction in QE likely means that it is coming soon. It has become increasingly apparent that the FOMC is uncomfortable with a Fed balance sheet that has reached $3.6 Trillion in size and Chairman Ben wants to get the unwinding process started before he leaves.

Now if we combine these two stories, imminent tightening by the Fed and a medium-term promise of no tightening by the BOE one might expect the pound to suffer a bit. However, once again the perversity of the FX markets shows through and instead we see the pound higher. I wish I had a good explanation for that, but alas, I just don’t know. Arguably positioning ahead of the QIR has played an important role in the move, but for now, it seems momentum favors a continuation to at least 1.5540 and perhaps as high as 1.5750.

Elsewhere in the G3, the yen has been strengthening further, trading below 97 overnight as the BOJ heads into its 2-day meeting tonight. There is no expectation for the BOJ to ease further now and surveys point to no expectations for any policy adjustment until next April or May. The 2.0% inflation target remains far from the current readings, but it seems that the market is more focused on the fiscal picture and Abe’s regulatory efforts rather than more BOJ activity. That’s not to say that buying ¥7 Trillion/month is not significant activity, its just already factored into the price. While my long term view remains a much weaker yen, the shorter term picture is far less clear. Could we trade back to 94-95? Clearly that is viable. However, if I were a yen recievables hedger, I would see that as a golden opportunity to manage my risk.

The euro is the least interesting major today, little changed despite more good news from Germany (IP +2.4% in June). As we are just in the beginning of August and holidays are rampant throughout the Continent, I expect there to be little in the way of new news to drive things here for several weeks yet.

But while the dollar has suffered vs. the pound and the yen, it has rallied vs. the AUD ahead of the Australian labor report tomorrow. That report is expected to show a rise in the Unemployment Rate to 5.8%, which would be its highest since January 2010. We continue to see the INR decline, although it has not yet reached the historic lows set earlier this week. The new RBI Governor, Raghuram Rahan, will have his work cut out for him to try to get India back on track when he starts on September 5. BRL remains a mess, still hovering at the 2.30 level as the Central Bank keeps on trying to prevent any further mishaps there. The bulk of the EMG currencies are a bit weaker this morning, apparently having taken the FedSpeak into account, but movements have not been very large overall.

There is no data of note today in the US, but what we are seeing is lack of liquidity having a real impact on price action. The key to managing risk in this type of market is to leave orders at a comfortable level. This demands patience.  So be certain you (and your management) have that if necessary.

Good luck

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