Notes From Underground: The Bank That Kicked the Hornets Nest

The release of Thursday’s U.S. employment data synchronized with ADP’s private sector report of 281,000 jobs created. The Department of Labor had a gain of 288,000, including the strongest growth in government jobs since the onset of the great financial crisis. Being that July 3rd had very limited volume because of the holiday weekend, it was difficult to determine the genuine nature of the shortened trading activity. Thursday did see a rally in the SPOOs, a strengthening in the U.S. dollar and a downside correction in the precious metals. The most difficult market was the interest rate and yield curve. The immediate reaction was a sizable selloff in all interest rate tenors but by day’s end the LONG END recovered and the 2/10 was a bit flatter. Yesterday saw a correction in the SPOOS as some analysts now believe the FED will bring the projected hike in interest rates forward to a rise in the second or third quarter of 2015.

Goldman Sachs released an analysis by their chief economist Jan Hatzius changing the forecast from a rate rise in the first quarter of 2016 to the third quarter. (Goldman Sachs is held in high esteem by the “Street,” but as those who actually trade may say, “Seldom Correct,Never In Doubt,” though that could well be applied to a multitude of sell side purveyors of pabulum.) Goldman’s and others change in forecast did have an impact on the yield curves today as both the 2/10 and 5/30 made attempts to revisit the flattening bias seen in June.

If the FED actually moves up its “forward guidance” on a RATE INCREASE, will that have a large market impact? It depends on how dramatic the FED‘s efforts to achieve its DUAL MANDATE are in reality. If the FED goes on a very slow program of raising rates, nobody knows how the market will judge the FOMC. The theme of NOTES FROM UNDERGROUND is/will be the credibility of central banks and how the financial markets respond. Today, post Goldman change in forecast, the flattening of the yield curves gives the FED a positive review. But in defiance of this the GOLD did rally from an $11 break to close higher at 4:15 p.m. CST. As Dylan sang and it applies to the FED:

“The line, it is drawn, the curse, it is cast

The slow one will later be fast

Oh, the times they are a changin'”

(Though maybe Janet Yellen will have to change her tune on jobs and wages.)

***Lost in Thursday’s U.S. centered news was the “shocking” interest rate cut by the Riksbank, Sweden’s central bank. The market was anticipating the rate to remain unchanged although a few analysts had projected a cut of 25 basis points. The RIKSBANK surprised the market by lowering the overnight rate by 50 basis points to 0.25%. The Swedish bankers voiced their concern about low inflation and therefore felt the need for a sizable cut.
The astonishing fact is that the bank’s announcement noted the following: “The low interest rates are already contributing to a rapid increase in household debt as a percentage of household income. An even lower repo rate will strengthen this tendency, thus increasing the risk of the economy developing in an unsustainable way in the long run.” This is an astonishing statement. The economy is strengthening but the bank deems it necessary to cut the overnight rate to near zero. THIS IS NOTHING MORE THAN SHOTS FIRED IN A CURRENCY WAR AS THE SWEDISH CENTRAL BANK ATTEMPTS TO STAVE OFF THE EFFORTS OF THE ECB. In a low inflation environment the Swedes are kicking the hornet’s nest in an effort to avoid the sting from of the ECB’s negative interest rate policy.

***More form the currency war front. A headline in Monday’s Financial Times centered on the French fury over the dollar’s global dominance. French Fiance Minister Michel Sapin called for a rebalancing of currencies used for global payments. This is not a new subject for French politicians since as far back as the 1960s Valery Giscard d’Estaing was decrying the U.S. dollar’s exorbitant privilege. Finance Minister Sapin was quoted in the FT: “We Europeans are selling to ourselves in dollars, for instance when we sell planes …. I think a rebalancing is possible and necessary, not just regarding the euro but also for the big currencies of the emerging countries, which account for more and more global trade.”
This statement is devoid of logic and reason for as the French implore Mario Draghi to pursue policies to weaken the euro, does the French FM understand that a move away for the international reserve status of the DOLLAR will result in a strengthening of the euro? The European economy is as large as the U.S. and if currency values are set on a pure trade weighted basis, the EURO will strengthen in any mass global portfolio rebalancing … INSANITY plagues the global financial system.
To make matters worse for Finance Minister Sapin, in tomorrow’s FT there is an article titled: “ECB Under Pressure to Tackle ‘Crazy’ Euro.” Seriously, I can’t make this news up. The CEO of Airbus passenger jet business suggests that the ECB should intervene to lower the value of the euro by at least 10 percent. Fabrice Bregier maintains, “Europe cannot be the only economic zone of the world that doesn’t consider its currency as a weapon … as a key asset to promote its economy.” The French CEO just wants the ECB and its euro to behave as other central banks act and cites the 20 percent devaluation of the yen. The German response to the FT reporters from an unnamed official: “We do not need to talk the euro up or down. Currency manipulation is not a route to competitiveness, it is a soft alternative to hard explanations to the electorate.” Let the Currency Wars Commence, but remember the multiple stings of “Kicking The Hornet’s Nest.”

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9 Responses to “Notes From Underground: The Bank That Kicked the Hornets Nest”

  1. arthur Says:

    The US Dollar is part of 87% of all trades in the global foreign exchange market (Bank for Intl Settlements)

  2. asherz Says:

    Michel Sapin’s comment follows the recent trade agreement between China and Russia that will settle a $400B natural gas contract in Rubles and Yuan.instead of the petro-dollar. These statements and actions are not so much economic calculations as they are political. The dollar hegemony in world trade gives the U.S. a great advantage over everyone else. With the U.S. withdrawing from its role as the world’s policeman, leaving in its wake a vacuum to be filled by other players, political leaders of rival powers now see that this is the time to knock the power of the greenback down. We saw similar results a century ago with the pound sterling when the British navy returned to its harbor. Edward Gibbon wrote a long book about a comparable occurence over 1500 years ago. Currencies were affected there as well.
    Plus ca change, plus c’est la meme chose.

  3. yra Says:

    Asherz—point is well taken and that is the outcome of a changing world and the effort by the FED to undermine its own credibility is an important underlying current.And Arthur ,with the major central banks in a battle with the BIS ,there is much more uncertainty to come–and soon.

  4. kevinwaspi Says:

    Amen, let the currency wars CONTINUE:
    0929 GMT [Dow Jones] 4:29amCDT
    SNB Speak: Negative Rates Coming?
    Swiss June inflation fell 0.1% on the month, taking the annual rate back to zero. While Swiss inflation is running in line with the latest SNB forecasts, the analysts at BNP Paribas say that if June becomes part of a renewed weaker trend, then the central bank may be forced to look at other measures besides the 1.20 EUR/CHF peg, a negative reserve rate being one of them. (gary.stride@wsj.com) Contact us in London. +44-20-7842-9464 Markettalk.eu@dowjones.com (END) Dow Jones Newswires

  5. ShockedToFindGambling Says:

    Yra- Great post

    You said “Today, post Goldman change in forecast, the flattening of the yield curves gives the FED a positive review”.

    That’s not how I would interpret the flattening 2/10 yield curve.

    With 2 year rates pegged to Fed Funds (which no one expects to go up a lot in the next 2 years), the 2/10 yield curve is mostly governed by movements in the 10 Year.

    So my interpretation is that the Treasury market is saying that FED policies will not be sufficient to sustain the real economy and therefore inflation will stay relatively subdued (However, I think that inflation for the typical American is much higher than the official numbers).

    I know you are talking inflation expectations, but IMO, a mini flight to quality does not “give the FED a positive review” under any scenario.

  6. yra Says:

    Shocked–I agree with you which is why for the last eight months I have argued in the blog ,on television and at times with my positions that Bill Gross was wrong in touting the 5 year note as his choice to be long—the 5 year has been a negative yield for a long time and I think what you are saying,is that the 10 and 30 years at least offer a positive real yield on a capital asset,unlike the five year.But why I am cautious here is because of the strong flattening move since the end of last year and my fear of Yellen undermining Fed credibility,but your point is well respected–which is why I keep reminding readers and viewers that the 2/10 may be flattening but is far from flat.If the Fed was acting more responsibly I think the curve would be flatter

  7. yra Says:

    Waspi–good points indeed and certainly to be watched but there is no doubt that the Swedes fired a howitzer in the currency wars and the French have certainly heard the recoil loud and clear

  8. kevinwaspi Says:

    Yra,
    Amen, you are spot-on with the move by the Riksbank. In history, it is often the smaller rather than the larger spot on the map that triggers the war. (Sarajevo, Devhenke, …)

  9. ShockedToFindGambling Says:

    Bad auction, FED gives date for ending QE, stocks up moderately….. and bond yields are down.

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