Jedi Central Banking

Remember those fund managers who said they were kicking themselves for missing the “lower for longer” hints dropped by Bernanke over $250k dinners?  [ if you don’t…]

Even Bernanke is supposed to have expressed surprise afterwards that anyone listened to him, given they didn’t always bother to afford him the same interest when he was actually in charge.

Within this anecdote is a key point about the market right now. Markets are supposed to move ahead of central banks. Just because they tell us something, doesn’t mean it is so. A promise is not a forecast. Even their promises change. Didn’t Mark Carney just drop forward guidance? Haven’t the Fed moved to watching a ‘range of indicators for the labour market’? In fact, central banks are enthusiastic subscribers to Keynes’ dictum: When the facts change, sir, I change my mind.

The problem has been the data. An unusually cold winter wiped out a quarter in the US – which suggests a rebound in Q2 (that we’re already seeing) but what of Q3 and beyond? Keep your eyes focused on wage inflation. That’s the key part of the puzzle. The trouble is, it’s a lagging indicator. Once we’ve got there, the central banks will be far behind the curve. But we know they want to be, so why isn’t the market moving ahead of them?

Beware those droids you think you’re looking for.

Why #Clegglookingsad matters

Amid the hysteria about the European election results (Neo-nazis! Racists! Feminists! Satirists!), let’s pick out what really matters. (Though if you do want a good summary of those extremists, here’s the Guardian’s take:

The result signals a potentially destabilising period for the coalition – the first since its creation. The market has forgotten about those febrile days just after the May 2010 election, with the main political parties thrashing out a way to set up not only the first coalition since the war, but a solid one.
There have of course been strains. The failed AV referendum. The Lib Dems u-turn on tuition fees. The Lib Dems putting the kibosh on long-held Tory plans to redraw constituency boundaries. And who exactly was responsible for raising the personal allowance, taking many more people out of tax?
Now, though, it’s only a year until the General Election. Both parties will want to split before the campaign begins; neither is served by a “joint platform”. Now, the blue touchpaper has been lit for both parties’ discontented fringes. The left of the Lib Dems can call for Clegg’s head, while the right of the Tories can argue for more UKIP.
This is why the next two weeks are so important.
1) Clegg has refused to resign, but politics is moving ahead of him. Leaking, counter-briefing is already underway. Today his allies claim Vince Cable’s supporters are deliberately seeking to destabilise him:
2) The Newark by-election on June 5th. This is a safe Tory seat, with a majority of 16,000, so a UKIP win is very unlikely. But that sets the bar very low for UKIP to claim they’re making serious in-roads into the Tory vote.
Volatility in the market is low: 3month EUR/GBP vol is just under 6% – it was at 7.5% at the start of this year, while 3month GBP/USD stumbles along at its 2007 lows of 5%. Politics has a habit of throwing up surprises.
Even if Clegg survives and Cameron holds his nerve, with the coalition limping through the summer recess, then we have the small matter of the Scottish referendum ahead…

What happens when you’re not looking

As I write the Euro is heading towards the high printed at the end of last year, 1.3893. This just after Bloomberg’s Chart of the Day on Monday was entitled “Euro suffocated as 2014 Range is the least on record” – in other words, the Euro has never started the year in a tighter trading range versus the dollar than it has now (see attached). Ironically the previous low was 2007 and we all know how that year ended up (the words “Northern” and “Rock” spring to mind). Implied EUR/USD volatility is also back at the lows of 2007.

Frustration and disinterest abound. Today’s non-farm payrolls is the least eagerly anticipated for months, as the market has had to contend with the impact of weather on data which is apparently the key input for the Fed’s reaction function. What normally happens in markets when people aren’t looking? That’s when trends begin…

So what could we see from here? Mr Draghi yesterday sounded relatively upbeat, and why shouldn’t he. Money market rates have fallen back to their lows, peripheral yields continue to tighten (Spanish 10years now half the levels of 2 years ago), and his favourite economic measure – the PMIs – are picking up. “But what about all the deflation?” cry the doom merchants. Well that was a natural consequence of restructuring economies within a fixed exchange rate regime. If it became entrenched, Draghi would argue that they have a long toolkit of measures they can use. Indeed the open debate within the ECB over the last few months is a sign that he’s getting his ducks in a row should the need arise. Government by consensus requires that debate.
So the ECB are letting their balance sheet shrink just as others are increasing theirs. 1.4000 on EUR/USD would be a pain trade for underhedged European corporates. Alongside this, risk sentiment continues to show resilience. Despite everything thrown at it, from a Fed who reiterate their commitment to taper despite the weather, to Ukraine/Russia/WW3 worries, the stock market carries on going up regardless. The Nikkei is now down only 6% YTD, having previously been the worse performing stock market of the year. It’s all good news until it isn’t, so watch out for buyers of EUR/JPY in the near term as “Goldilocks” plays out for the financial markets – not too hot, not too cold, and don’t make me think about the 3 bears.