The market moving comments from Ben Bernanke came in the Q&A and were not part of the carefully structured message. However, falling inflation expectations could be a key element to push QE tapering back from September towards later in the year, says Simon Smith of FxPro.
In the interview below, Smith also discusses the gentle situation in the euro-zone, the forward guidance in the UK, the end of the “China put” and Japan’s upcoming elections and the impact on the yen.
Simon has over seventeen years experience of macro forecasting and investment strategy research. Prior to joining FxPro in May 2010, Simon was a consultant with Thomson Reuters, having spent four years as Chief Economist at Weavering Capital. He has held economic and strategy positions with Standard & Poor’s, together with consultancy firms 4Cast and MMS International. Simon holds an MSc. in Economics from the University of London and a BSc. from Brunel University.
1.Bernanke sounded relatively dovish in his recent speech, but didn’t really say anything about tapering. When can we expect the Fed to make a change in policy?
His comments last week were made in the Q&A section after his speech, rather than the speech itself. This means that they were perhaps not as structured as if they came in a prepared speech, so there is a greater likelihood that markets concentrate on one element, or phrase, rather than a carefully constructed overall message. The FX market was out-sized compared with elsewhere and to a large degree reflected the extent of long dollar positioning. After the ECB/BoE decisions and prior Fed statements, the feeling was that all was clear in FX markets (dollar up, Europe down), but things are rarely ever that clear.
The Fed has been has lead in the way in ensuring that there is clarity on what their exit strategy is dependent upon. We know the labour market is key, given that this has lagged the recovery in the wider economy and overall employment remains below the peak seen in early 2008. But inflation expectations, which have been falling of late, also need to be put into the equation. If the labour market keeps improving, falling inflation expectations could be the element that delays the start of tapering from September to later in the year.
2.Portugal is suffering a political crisis, with yields rising. Greece and the troika are negotiating, Spain’s PM is facing corruption issues and both Italy and France have received credit rating downgrades. Can the debt crisis get back into full swing or will Germany make an effort not to rock the boat before the elections?
There was always a danger with the ECB’s pledge to do “whatever it takes” to save the euro last year (introducing the Open Market Transactions program) would serve to mask the underlying problems, reducing the incentive for the required longer-term reforms. In some cases, leaders were confident enough to say that the worst of the crisis was over. But deep down, there are fairly simple dynamics at play to solve a credit crisis. The choices are to become more competitive (internally devalue), devalue your exchange rate (externally devalue), inflate your debts or default/restructure. In reality, it’s a combination because there are contradictions if you try and do everything at once (such as inflate away debt and become more internally competitive). The bottom line is that there are no quick fixes, the worse may well not be over and Germany if anything is likely to adopt a stern line ahead of the elections to those that are looking for an easy way out.
3.Mark Carney warned about interest rates. With relatively high inflation in the UK, does he have real tools? Or is some kind of forward guidance the only option at hand?
His warning came because the market was starting to price higher rates from the UK central bank next year, although this was largely as a result of the rising interest rate expectations from the US. Forward guidance is good for only as long as people believe it. We’ll likely get more detail next month on what exactly the UK is pledging and why. In the meantime, the fact is that the UK economy has performed relatively well in the second quarter, possibly growing by as much as 0.8%. But the worry is whether the economy has reached the escape velocity required. With real incomes still constrained and the Eurozone in recession, it still looks premature to assume so. This is why he wanted to ensure markets did not push for an ‘early’ rise in rates.
4.The authorities in China have taken a more tough approach to the banks, trade invoices and even growth. Can this move have a real effect on the global economy?
Absolutely. China was a key counter-weight to the slowdown in 2008-09, but the problem is that the fiscal stimulus and other measures that were employed to soften the impact of the global slowdown have stored up complex problems that are now starting to bite. China has a long-held ambition to rebalance its economy and it’s pretty obvious that the economy cannot grown at prior rates indefinitely. It’s already having an effect, both on a structural and cyclical level. On the former, the US is realising that it has to become more self-sufficient on energy. It cannot run endless current account deficits forever, especially if one of the key financing nations of such deficits will have less savings to export. On the cyclical front, it’s the fact China cannot be the counter-weight it was previously and that has to be built into the thinking developed nations. The “China put” for global demand is no longer there.
5.Japan is facing elections for the upper house in the upcoming weekend. Can a victory’s for Abe’s LDP add upwards pressure on USD/JPY?
It’s really the extent of the victory that is likely to be the issue for the yen. A strong showing will be seen as giving the mandate required to push through key elements of Abe’s third arrow of structural reforms. Changing what has been the norm for decades is hard for any government, but particular for Japan which has a history of leaders falling by the wayside after a fairly short period in office. It will be hard, which is why although USDJPY does have further upside, it’s not going to be a clear one way trend as was seen November to May, even if the LDP gain a strong electoral showing.
Further reading: ECB: Decent chance of a negative deposit rate, just not in June; Fed to taper in 2013
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