Inappropriately Timed

The boys in the Fed are now fighting
Which could make things much more exciting
Bernanke explained
QE could be drained
Then Bullard had words that were biting

The Chairman’s speech was premature
Since right now we just can’t be sure
Of how the US
Will meet with success
Which our buying bonds did ensure

As we walk in to the final day of what has been a pretty dramatic week with respect to market movement, the headline that jumps out to me is the comments from St Louis Fed President Bullard that the Chairman’s remarks were “inappropriately timed”.  This is the Fed’s dirty laundry out in the open and it has been sufficient to roil markets.  One of the things Bernanke has been doing while Fed Chairman has been his effort to bring transparency to the Fed process.  And while I am fully in favor of transparency, I understand that one of its consequences is that there will be more volatility resultant from that transparency.  The question is, does Ben?  After all, think about how markets work.  Traders and investors take the information they have, analyze it and establish their views, then take a position accordingly.  We all know that there are both bulls and bears in any given market, so there are always going to be different views.  But what transparency adds to the situation is that as internal dissent within the Fed becomes clear, it can serve to undermine the perception of the Fed having conviction in its actions.  Any sign of weakness in a central bank, especially the Fed, is an open invitation for markets to test that weakness.  And so now we have dissention in the ranks of the FOMC being played out in the open.  There is more volatility to come.

Yesterday’s FX movements were pretty impressive overall, with multiple currencies falling more than 2% vs. the dollar.  The overnight session has seen a bit of a rebound in the yen, but actually we have seen a continuation in the other major currencies.  The euro has suffered following the news that in Greece (remember them?) the coalition government has been weakened after its decision to close the national radio and television broadcaster, ERT, and fire 2700 government employees.  While this is a condition of the Troika bailout funding, the manner in which this occurred has not gone down well with the smallest member of the coalition.  This has also served to focus attention on questions about Greece’s ability to fund itself for the next year and called into question whether the IMF will continue adding money to the pot.  Euro weakness seems likely the future, although I don’t foresee a collapse, rather a steady decline.  The pound is softer despite better than expected budget numbers, with its deficit much smaller than expected.  However, the impetus from the ending QE story remains the key driver here.

In emerging markets, the PBoC finally injected some cash into the system last night.  This helped ease the growing credit crunch there and overnight rates fell by 442 bps.  It appears that the Chinese are still trying to figure out the best way to manage monetary policy in an economy that is growing at a much slower pace than in the past.  While the CNY is not likely to become extremely volatile any time soon, the impact on other Asian currencies is almost certainly going to be large.  The combination of the Fed changes and the PBoC squeeze has resulted sharp declines in all Asian currencies during the past week, led by INR, but pretty much across the board.  Funds continue to flow out of emerging market economies, both equity and fixed income, and this process is just getting started.  Asian central banks have been actively intervening to prevent a collapse in their currencies, but the weakening trend is going to continue as long as the Fed story remains.  Right now, most of these countries are fine, as they were actively selling their currencies during the past two years to prevent excessive strength, but history shows that defending a weakening currency is a much more difficult process, and if this pressure keeps up, we could start to see other macro policy changes that have real economic impacts, rather than simple FX intervention.  This is simply more of the fallout from Chairman Ben’s transparency initiative.

Finally in Brazil, the protests that I mentioned earlier this week are growing, with more than 1 million people taking to the streets around the country yesterday.  While Sao Paolo has rolled back the bus fare hikes that started it all, it has not been sufficient to end the protests.  Last night resulted in the first casualty in the situation, but I fear there will be more before it is over.  The question is: will President Rousseff be able to address the concerns, which seem to center on corruption in the government?  It is always difficult for a government to look inward and address its own foibles, and I don’t see any reason to believe that this situation will be different.  So to me, these protests are likely to continue for a while, possibly right up until the World Cup, and the BRL probably has further to fall.  I wrote that there was only a 20% chance of a more substantial decline in the Real, to beyond 2.50, but as I read more about what is happening on the ground there, I fear that probability is growing.  I think it is up to a 1/3 probability of a significant decline and those odds are likely to grow.  If you are a receivables hedger in BRL, be very careful.   Things could get ugly in a hurry.

Good luck and good weekend