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Stock market turmoil continues. GBP gets a boost from BoE rate hike talk though it does depend on smooth Brexit progress.

By Nick Parsons

We warned yesterday to watch out for a choppy day for the pound, not least because there was such a split of expectations on the timing of the next Bank Rate hike that there were bound to be analysts, investors and institutions forced to reassess their own forecasts. In his appearance before a House of Lords Select Committee last week, BoE Governor Carney had hinted that the Bank was preparing to upgrade the forecasts in its Inflation Report and this is exactly what happened; albeit the language was more aggressive than had been expected. GBP/USD surged more than 1½ cents from just below 1.39 to a high just over 1.4050. So far, so easy to explain…. Within the space of four hours, however, as the carnage continued in US asset markets, GBP/USD had reversed all its gains, coming back to its launching point with the precision of a Falcon-Heavy booster. GBP was still the best performer of the day although its 200+ pip gains against both the AUD and NZD were more than halved.

In revising up both its UK and world growth forecasts, the Bank of England said that, “Over the past year, a steady absorption of slack has reduced the degree to which it was appropriate for the MPC to accommodate an extended period of inflation above the target. Consequently, at its November 2017 meeting, the Committee tightened modestly the stance of monetary policy in order to return inflation sustainably to the target. Since November, the prospect of a greater degree of excess demand over the forecast period and the expectation that inflation would remain above the target have further diminished the trade-off that the MPC is required to balance. It is therefore appropriate to set monetary policy so that inflation returns sustainably to its target at a more conventional horizon. The Committee judges that, were the economy to evolve broadly in line with the February Inflation Report projections, monetary policy would need to be tightened somewhat earlier and by a somewhat greater extent over the forecast period than anticipated at the time of the November Report, in order to return inflation sustainably to the target.”

In his subsequent Press Conference, the Governor was keen to play down the scale and speed of interest rate hikes and despite much probing from journalists, refused to agree that interest rates are likely to rise in May. The Statement noted, “Any future increases in Bank Rate are expected to be at a gradual pace and to a limited extent”. Market pricing doesn’t yet have a May hike as a done deal, though the implied probability of a 25bp increase has increased from just under 50% to something nearer 70%. All this, of course, is predicated is based on two Brexit factors - that there is “a smooth transition”, and that it leads to an “average of potential outcomes”. Let’s see now what the politicians can do to facilitate this…

The volatility across asset classes continues with the Dow Jones Industrial Average down 1,000 points yesterday. The latest move lower came with little or new fresh news, and amidst a general feeling that many of the forced buyers of VIX had already covered their short positions earlier in the week. Instead, there’s now a worry that the so-called ‘risk-parity’ funds might be the next wave of forced sellers, liquidating positions as both equities and bonds are delivering simultaneous negative returns. The US Dollar tends to do well in periods of asset market chaos and so Thursday was another day of general USD strength its index against a basket of major currencies climbing to a two-week high around 90.25.

Federal Reserve Bank of New York President William Dudley said recent stock-market declines weren’t that big and don’t yet change his outlook for the U.S. economy. “This wasn’t that big a bump in the equity market… The stock market had a remarkable rise over a very long time with extremely low volatility…. My outlook hasn’t changed just because the stock market’s a little bit lower than it was a few days ago. It’s still up sharply from where it was a year ago. Having a bump up like this has virtually no consequence on my view of the economic outlook”. In US stock markets over the past tow decades, there has been lots of talk of the “Greenspan put”, the “Bernanke put” or the “Yellen put” to describe how stock market traders feel they are insured against declines by the Federal Reserve Bank. Perhaps the strike price on the “Powell put” is a bit lower than they’ve become used to…

There are no major US economic data releases scheduled for today and FX traders have never, ever been interested in wholesale sales numbers. However, the inventories number feeds directly into the Atlanta Fed GDP model which will be updated later this afternoon and currently estimates Q1 GDP at 4.0%. The USD index opens in Europe this Friday morning around 89.95.

We noted here yesterday that there were some tentative signs that investors might have been lightening up their positions in what had been one of the most crowded trades in the investment universe: long EUR/USD. On Wednesday, the pair fell on to a 1.22 handle for the first time in two weeks and – remarkably, given the volatility elsewhere – it has stayed on the same big figure for every minute of the past 36 hours.

ECB Chief Economist Peter Praet hosted a Q&A session on Twitter yesterday morning; an innovative and transparent method of improving central bank communication. He said the salary increase secured by Germany’s largest trade union this week is “fully in line” with the European Central Bank’s inflation forecasts. His comments dampened speculation that the 4.3% pay rise negotiated by labor union IG Metall and the Suedwestmetall employers’ federation in Germany - which we spoke about here earlier in the week - would prompt the ECB to raise its inflation forecasts and to tighten policy faster. Asked what he would choose if he could pick just one measure of inflation, he said, “If I really had to pick one, I would take the simplest one: core inflation.” Asked about economic models, he said, “Models are important to help us think about economic developments in a structured way, but the real economy is always more complex than models. Always to be complemented by other approaches, conjunctural analysis, and even anecdotal evidence!”

Mr Praet even displayed a great sense of humour for a central banker. One questioner asked, “Peter, how do we pronounce your name? Is the 'e' silent?” and received the classic reply, “In Praet indeed, but not in Peter.” Not to be outdone, his colleague and Executive Board member Yves Mersch said at an event in London that, “At these speeds, if you bought a bunch of tulips with Bitcoin, they may well have wilted by the time the transaction is confirmed”. Let’s hope that their peers around the world can make similarly witty and interesting observations as they try to explain the somewhat arcane business of monetary policy. The EUR opens in Europe today on ‘big figures’ of USD1.22 and GBP/EUR1.13.

The Australian Dollar continued to fall on Thursday as commodity prices moved lower and volatility remained elevated across asset classes. These are two of the three main drivers (along with interest rate differentials) of most of the valuation models of the currency. Gold has now fallen $50 per ounce since last Thursday whilst in the base metals, aluminium is down more than 4% over the same period. AUD/USD is now down over 3 cents from its recent high of USD0.8130 and is on a US 77 cents ‘big figure’ for the first time since late December.

In his speech to the A50 Australian Economic Forum dinner, RBA Governor Phil Lowe did not sound a man in any hurry to raise interest rates. He said, “given recent developments in Australia and overseas, it is likely that the next move in interest rates in Australia will be up, not down. If this is how things play out, the likely timing will depend upon the extent and pace of the progress that we make. As I have discussed, while we do expect steady progress, that progress is likely to be only gradual. Given this, the Reserve Bank Board does not see a strong case for a near-term adjustment in monetary policy. It will of course keep that judgement under review at future meetings.”

Overnight the RBA released its latest Quarterly Statement of Monetary Policy; a 68-page document summarizing the current state and future outlook for the Australian economy. Essentially, there is hardly any change from the November view though the one-year forecast for unemployment has been revised down 0.25% to 5.25%. The main phrase for interest rate and currency markets was that, “Over the course of 2017, the unemployment rate declined and inflation increased a little. The accommodative setting of monetary policy has played a role here. Further progress on both fronts is expected over the next couple of years. It will be some time, however, before the economy reaches current estimates of full employment and inflation returns to the mid-point of the target”. It is interesting to see the RBA is now stressing the ‘mid-point’ of the inflation target and it is this which has prompted ANZ Bank to change its interest rate forecasts. It was previously looking for 2 hikes this year but now sees the RBA on hold throughout 2018.

Stepping back from the minute-by-minute movements and taking a bigger picture view, since the beginning of 2018, USD/CAD has been largely contained in a range from the mid 1.22’s to 1.26 even though we have seen extreme volatility in equity markets, a 25bp rate hike from the Bank of Canada and ongoing uncertainty over the renegotiation of NAFTA. In yesterday’s New York session, the pair rose briefly through the top of the range but the break lasted less than two hours and soon returned to the 1.25’s.

In its latest monthly poll, Reuters reports the Canadian dollar is forecast to strengthen over the coming year as expected Bank of Canada interest rate hikes and broad pressure on the US dollar offset uncertainty over the future of the NAFTA trade deal. The poll of more than 40 foreign exchange strategists predicted that the loonie will edge up to C$1.250 to the greenback, or 80 U.S. cents, in one month, from around C$1.255 on Wednesday. After a period of stabilization, it is then expected to climb to C$1.230 in a year. A cynic might well observe that these moves can be seen in less than one day, let alone a year…

Bank of Canada Senior Deputy Governor Carolyn Wilkins gave an interview to Reuters yesterday evening saying Canada’s high household debt is the biggest vulnerability facing the economy, while uncertainty about NAFTA is weighing on the outlook. “Every household is going to find it more or less difficult, so some households might find it extremely difficult, others will just need to tighten their belt a bit, but overall as you can see from our projection, we expect the economy to continue to grow, we expect consumption to continue to grow.. I think we are being very clear that the biggest vulnerability to the Canadian economy is coming from high household indebtedness.” Wilkins declined to give “a running commentary” on recent economic data, but said that although GDP growth in the fourth quarter got off to “not the strongest start,” the latest data remained in line with forecasts. This afternoon we’ll get to see the latest labour market report where consensus is looking for only a 10k rise after a 78k gain in December.

The New Zealand Dollar has not been immune to the volatility seen across all assets and geographies. It was falling even before Thursday morning’s RBNZ interest rate announcement and then proceeded to fall even further as investors reflected on the contents of the Statement and the subsequent Press Conference. AUD/USD rose all the way from the mid 1.07’s to just under 1.09 whilst NZD/USD dropped on to a US 71 cents big figure for the first time in 3 weeks. By the end of the day in Europe, however, AUD/NZD had reversed all its gains and was back on a 1.07 handle and NZD/USD was back on 72 cents which, after a very quiet overnight session in Asia, is where the Kiwi Dollar opens in Europe this morning.

New Zealand house prices surged for the third month in a row in January, with the commercial centre of Auckland posting its fastest growth in more than a year, the government property valuer said on Friday. Quotable Value’s (QV) residential property price index rose 6.4 percent in the year to January, compared with an annual rate of 6.6 percent in the previous month. Values in the commercial centre of Auckland rose 0.7 percent and have jumped 1.6 percent in the past three months, the highest rate of growth since November 2016. QV said, “The easing of the LVR (loan to value ratio) restrictions for both investors and home buyers this month, along with continued strong net migration, low interest rates, and a shortage of housing supply means it’s likely we can expect moderate value growth to continue during February and March which are annually the busiest months in the housing market”.

The RBNZ’s formal comment on the currency in its monetary policy Statement was, “The exchange rate has firmed since the November Statement, due in large part to a weak US dollar. We assume the trade weighted exchange rate will ease over the projection period…. Monetary policy will remain accommodative for a considerable period. Numerous uncertainties remain and policy may need to adjust accordingly.” Speaking to reporters at the Press Conference, Governor Grant Spencer said on Thursday that the bank was not concerned about the New Zealand dollar, "We're comfortable with where it is," adding that the NZD strength was largely on the back of weakness in the US Dollar.