Rates on the move, central bankers behind the curve

Rates on the move, central bankers behind the curve
Ben Bernanke started it. Let’s assume the current round of forward guidance started two weeks earlier. Bernanke signaled the end of QE in the USA with the possibility of tapering assuming the US unemployment rate hit 7%. The end of QE could begin mid 2014 according to market analysts last week. Fed Statement June here.

You have to wonder why, with the economy growing at not far below trend rate before the great crash and the DOW soaring to new highs in May, the markets should be dependent on succour from the Fed soup kitchen to support market action for a further twelve months but that’s economics USA. The great Fed - Wall Street Alliance.

The end of QE? US Non Farm Payroll data -
On Jobs Friday, the non farm payroll figure revealed 195,000 jobs had been created in the USA, above the 165,000 figure expected. Analysts began to speculate the end of QE could materialise as early as September this year. US Ten Year Treasury yields jumped to 2.74 at close this week and the Dow closed above the 15,000 level.

Like it or not the great QE experiment is almost over, all over the world. We should make ready for the great exodus from Planet ZIRP. US base rates could begin to rise by the middle of 2014 - the UK will follow within six months.

Europe whatever it takes for as long as it takes .
In Europe the ECB said it expects key rates to remain at present or below lower levels for an extended period of time. “Whatever it takes for as long as it takes” is now the Draghi guideline. Latvia, Lithuania and Luxembourg may be the growth economies to envy but Croatia with negative growth and jobs falling is meeting the current conversion criteria for EU membership. We don’t expect an increase in Euro rates anytime soon.

UK - forward guidance
In the UK, we expected forward guidance from the New governor would wait until August. But no. The MPC statement on Thursday, held base rates and QE but added “in the Committee’s view, the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy”.

What are they talking about? In the recent Inflation Report, the bank had offered the “market conditioning path for base rates” as some form of base rate outlook. No rate rises expected until 2016, the guideline presented by an elaborate manipulation of [OIS] swaps data. For once the markets were believing “that which the old lady would have them believe”. In recent days, the swaps guideline had begun to suggest base rate would rise in 2015. This followed the recovery in UK Ten year gilts yields towards 2.5% as central banks lose control of the yield curve.  

Should we really worry about the swaps data anyway? Markets have no idea about the future path of interest rates as our Chart of the Day clearly shows. An analysis of the implicit future path of interest rates over the last four years ranges from 4% to 0.5%. The chart looks more like a porcupine on heat, than a clear market signal to track and follow. Experience tells us that forward rates can tell us little about the future path of rates.

UK Economic Data
Better the attention is paid to the UK economic data. The economy is growing into the second quarter lead by a strong recovery in service sector growth according to the Markit/CIPS UK Services PMI®. The headline Business Activity Index recorded 56.9 in June, up from May’s 54.9 and the highest reading for 27 months. In the manufacturing sector, the UK Manufacturing PMI hit 52.5 in June, up from a revised reading of 51.5 in May, the index posted above the neutral mark of 50.0 for the third month running. In the construction sector, PMI companies indicated a further moderate rise in business activity during June. This was highlighted by the index 51.0, up fractionally from 50.8 in May and above the 50.0 no-change value for the second month running.

In the car market, according to the SMMT, new car demand was up 10% in first half of 2013. New car registrations passed the one million mark in June, growing 10% in the first half of 2013 to 1,163,623 units. The UK new car market saw the 16th successive monthly rise in the month, growing 13.4% to 214,957 units. Even in the housing markets, prices and volumes are beginning to move albeit from a pretty low base. The US economy is recovering as is the UK. The recovery in Europe will have to wait for some time yet. But for the UK, growth in the second quarter will surprise most analysts. We expect the economy to grow by between 1% - 1.5% this year.

So what of forward guidance?
The Governor will announce further guidelines on forward guidance in August. But great care is needed. Forward Guidance increases market volatility, it just gives the markets more things to fret about. The Governor must avoid becoming hostage to a monthly indicator, as Bernanke is hooked onto Non Farm Payroll data. Monetary policy is in danger of drifting behind the curve. Growth is emerging, the inflation challenge remains. If forward guidance leads to a fall in sterling, the inflationary pressures will increase. Sterling sub $1.50 as oil prices rise - will exacerbate inflation and stifle recovery. Weaker sterling will do little or nothing to stimulate export growth. Alas, the great dollar bull run has begun. 

What happened to sterling?
Sterling fell further on dollar strength at 1.4897 from 1.5220 and slipped against the euro to 1.1611 from 1.1687. The Euro dollar closed at 1.2827 from 1.302 and against the Yen, the dollar closed up 101.2 from 99.12. Yes, the great dollar bull run has begun.

Oil Price Brent Crude closed at $107.72 from $102.16. Average price in July 2012 was $103 approximately.

Markets, The Dow closed up 15,135 from 14,910. The FTSE closed at 6,376 from 6,215. Markets have rallied from lows, this is the time to average in. The call is FTSE 7000 end of year.

UK Ten year gilt yields closed at 2.51 from 2.46, US Treasury yields closed up 2.74 from 2.49. The feral hogs will not be cowed. Yields are set to move higher.

Gold closed down at $1,222 from $1232. Inflation will be back on the agenda soon. Watch out for the basing action.

Check out The Saturday Economist web site, and the new Chart of the Day Page. That’s all for this week, don’t miss The Sunday Times and Croissants out tomorrow. The Saturday Economist.com is mobile friendly, no need for a special app any more!

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John

The material is based upon information which we consider to be reliable but we do not represent that it is accurate or complete and it should not be relied upon as such. We accept no liability for errors, or omissions of opinion or fact. In particular, no reliance should be placed on the comments on trends in financial markets. The receipt of this email should not be construed as the giving of investment advice. It's just for fun, what's not to like! Dr John Ashcroft is The Saturday Economist.

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