Search ForexCrunch

Both the Fed and the BOE are likely to tighten sooner, as the risks of keeping near zero interest rates rates is moving to outweigh the benefits, says Simon Smith of FxPro.

In the interview below, Smith also discusses the  likelihood of QE in the euro-zone, its timing and effect, in addition to other topics. Enjoy:

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.

Following the recent strong NFP, Goldman Sachs brought forward its expectations for a rate hike in the US to Q3 2015. When do you see the Fed raising rates?

I think we are likely to see it earlier than that, more around Q2. This is partly predicated on my reasoning for expecting BoE to tightening rates this year, which relates to the risks of keeping rates near zero moving to outweigh the benefits. You can see a more open debate regarding the timing of tightening developing in the US and also the UK and I think this good. There are real dangers from getting too used to near zero rates.

Draghi left the door open to QE, while some other ECB members see it as a remote option. Do you think there is a chance that the ECB will announce such a plan later this year?

It seems more likely than not, but it is not going to be QE as we’ve seen from other central banks and it’s not something I am getting too excited about. Even leaving this aside, there is a difference between doing QE in the early part of the global financial crisis and now, both in its impact on the real economy and also in asset markets.   We know from the latest meeting that discussions are continuing, but there are strong reasons for keeping things in perspective and not getting into the mindset that this is going to crush the euro.

Most indicators in the UK point to a strong recovery, but the recent inflation report showed a more subdued rise in prices. Does the low inflation provide Carney more breathing space before he raises the rates?

We’ve seen some better numbers and the higher currency naturally acts as a brake on inflation as well. The reason for expecting a cautionary tightening from the Bank is the growing risks from keeping rates at their current level.   The housing market is publicised as one of the risks from this, although it’s naturally a lot more complex and better dealt with via other means. But, as the BIS illustrated recently (not for the first time), central banks need to be more aware of the wider risks from low rates, something which I think the BoE is starting to take on board.

RBA governor Glenn Stevens sent the Aussie down with his recent comments. Can this snowball into a large fall of the Aussie? Or is the effect only temporary?

I see it as capping the upside, rather than a major push lower on the Aussie. In some ways, it is surprising to that is has taken the RBA this long to become a little more concerned (externally) given the more pointed references that we saw at the end of 2014 when the currency was some 4% lower than current levels.

Volatility remains low and some commentators talk about market complacency. Is this the case? Could one “black swan” shake the whole system?

Much has been made of the parallels between now and 2007, when we were seeing similar levels of low volatility. I’ve had an uneasy feeling for some time that something does not feel quite right regarding the current environment in financial markets. As always, it’s one thing to say market are complacent, but it’s another determining when we will see the consequences of it and/or what such a ‘black swan’ event could be. Pulling it back to some of the other questions, this is why I think central banks need to take some of the heat out of the current situation, rather than wait for an external event to bring things crashing down.   They will say that it’s not their job to control asset prices, but they are part of the reason why volatility is so low, so have to take some part in the exit strategy.

Further reading:  Killing forward guidance