Last night, the US Fed decided to launch the much talked about ‘operation twist’, designed to push down longer-term interest rates by selling their short-dated holdings (less than 3 years) and investing in longer-dates bonds (6 to 30 years). Compared to what was expected, the market moved on from this around three weeks ago as many were looking for either QE3, or a strong indication that it was being considered. There were neither, which is why we’ve seen the dollar rise (on general risk aversion plays) and Asian stocks sell off.
The disappointment is also being registered in the typical risk plays, with the Aussie down nearly 2% since last night (AUD/USD flirting with parity) and the yen proving to be the more resilient on the majors. The intention is that borrowing costs are lowered for businesses and households, via the decline in longer-dated Treasury yields. This is no panacea though. The US ten year is already at 1.80%, so the downside is starting to look limited and short-term borrowing costs could well increase.
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Furthermore, bank balance sheets will be further strained as the spread from borrowing short-term and lending longer-term is diminished. As such, it could well be that the fall in Treasury yields (presuming it happens) is not fully reflected in corporate and mortgage rates as banks try to maintain profit margins. In sum, it’s a step in the right direction, but it probably won’t be enough to kick-start the economy.
Commentary
Pound wobbles after MPC support for QE. Although Adam Posen remains the only member of the MPC to explicitly call for additional asset purchases, the latest MPC Minutes made it abundantly clear that he is unlikely to stay lonely for much longer. Indeed, after months of sitting on the fence, these minutes were actually very refreshing in terms of the candour of the dialogue and the MPC’s preparedness to openly discuss the policy options they are considering. Policy-makers confessed that the debate on additional stimulus was finely balanced, with asset purchases the preferred option. Interestingly, a twist operation was also discussed, as was a potential reduction in the base rate (currently 0.5%) and an explicit commitment to a particular future path for rates. Especially revealing was the suggestion that most of the MPC regard additional QE as increasingly probable, in response to ‘significant downside news’ in the previous month. Confidence in their expectation that inflation will fall back to 2% next year remains undimmed. Unsurprisingly, the pound fell sharply, with cable threatening the 1.56 level at one point, a fall of almost ten figures in a little over one month. Also disturbing was the latest figures on the state of the public finances, with public sector net borrowing ex interventions of GBP 15.93bn last month, the highest August on record. That said, there was some good news in these figures, with revisions to previous months shaving GBP 10bn from borrowing. Ahead of the Chancellor’s autumn statement, this improvement will generate a cheer at the Treasury against the backdrop of growing calls for George Osborne to ease some of the relentless pressure of fiscal austerity.
The meltdown in metal prices. It has been unfolding rather gradually, but the consistent decline in base metal prices over recent weeks reaffirms the widespread fears that global demand has softened. Aluminium prices are down 6% so far this month, and down 17% in the last five months, copper prices have dropped more than 10% in September alone, while zinc has lost 18% in the past two months. Losses of this magnitude do not augur well for those high-beta currencies like the Aussie that depend on demand for their resources. The Aussie tested the 1.02 level once again on Wednesday – based on falling base metal prices alone, with disappointment on the Fed outcome adding to the softer tone overnight.
Choppy waters for the safe haven currencies. The safe haven currencies have been enduring some real choppiness in recent days. The Swiss franc for instance has been on the back-foot this week amidst growing speculation that the SNB may soon lift their EUR/CHF target to 1.25 (from 1.20 currently). The speculation was given additional credence later on by an advisor to the SNB, who claimed that the fundamentals suggested the EUR/CHF ought to be between 1.30 and 1.40. On Wednesday, the Swissie was not far short of 0.90, a level many would have thought inconceivable just six weeks ago when it briefly touched 0.70. EUR/CHF is above 1.22 and giving every indication of going higher still. Notwithstanding the threat of industrial-scale intervention from the BOJ, the Japanese yen has been creeping higher over recent days. In Wednesday’s Asian session, it briefly traded under 76 before spiking higher after rumours of the BOJ checking prices.
Tough times for the Russian ruble. Concern that the global economy is heading back into recession and heightened risk aversion have weighed heavily on most of the EMEA currencies over recent weeks. In the current quarter alone, the Russian ruble has lost more than 10% against the dollar, while both the Hungarian forint and the Polish zloty have suffered declines against the greenback of more than 13%. Russia’s currency has come in for some especially harsh treatment recently, with their dollar-euro basket falling 11% in just the past two months to a two year low. For some, the extent and the rapidity of the decline would be a surprise, given that the oil price has actually held up relatively well. Also, Russia’s growth outlook still appears fairly robust, notwithstanding the downward revisions to both 2011 and 2012 announced by the IMF yesterday. Growth for both years is still expected to be above 4%. Of additional concern for the Russian Finance Ministry would be the collapse in demand for government debt in recent months, which has complicated their financing task. Indeed, today’s auction of RUB 10 bn of notes had to be cancelled due to a lack of demand. Interest rates on ruble-denominated bonds have risen markedly over recent months, at a time when yields in some of the major markets such as Germany, the UK and the US have declined significantly. Especially troubling is that domestic investor interest for ruble bonds have dried up, at a time when foreign buying has also disappeared. The storm-clouds for Russia’s currency are unlikely to lift any time soon. Clearly, international investors are worried that another global recession will result in a significant reduction in oil prices, which would really hurt an economy like Russia where 40% of government revenue comes from oil.
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