Notes From Underground

Today, the BOE raised interest rates (as expected). But the market deemed it to be dovish and the EUR/GBP rallied 2 percent as the British pound tumbled and the euro strengthened versus the pound and dollar. On Wednesday I cautioned that the EUR/GBP failed to hold below its 200-day moving average and this provided a good technical level. As expected, the FOOTSIE index rallied more than 1 percent as investors appreciated a weaker POUND as beneficial to British corporations regardless of Brexit. The initial release of the statement revealed a 7-2 vote, which on first read was not the expected 6-3 vote so could have been a bit hawkish. But the eight paragraph statement clarified the soft-side of Governor Carney:

1. “Net trade is bolstered by the strong global expansion and the past depreciation of sterling”;
2. “The overshoot of inflation throughout the forecast predominantly reflects the effects on import prices of THE REFERENDUM-RELATED FALL IN STERLING” (emphasis mine);
3. “Monetary policy cannot prevent either the necessary real adjustment as the U.K. moves toward its new international trading arrangements or the weaker real income growth that is likely to accompany that adjustment over the next few years. It can, however, support the economy during the adjustment process. The MPC’s (Monetary Policy Committee) remit specifies that, in such exceptional circumstances, the Committee must balance any trade-off between the speed at which it intends to return inflation sustainably to the target and the support that monetary policy provides to jobs and activity.”

These three points seem to support the idea that the BOE/MPC is willing to tolerate higher inflation as an outcome of the need to pursue a WEAK STERLING policy. The BOE did this when the Great Financial Crisis hit as relief for the British economy was found in a depreciated pound. The British currency dropped 30% against the euro between December 2007 and December 2008 (0.7350 from 0.9803), thus allowing the U.K. export sector to pick up some of the slack. It seems that Governor Carney wishes to pursue a similar path. A weak POUND may push import prices up, but a rise in exports– and supporting jobs–is worth the short-term pain. In central bank terms, import inflation is deemed TRANSITORY. The British economy is at “full-employment” but it appears that Governor Carney believes this to be at risk because of Brexit. A rate rise is not always bullish and noted inflation worries will not always send bond yields higher. The 10-year British gilt yields actually fell 8 BASIS POINTS, indicating just how wrong-sided the market was in anticipation of a HAWKISH statement.

***Tomorrow’s jobs number will be  a difficult read as markets adjust to the post-storm correction to last months 33,000 job loss. The CONSENSUS is for 312,000 nonfarm payrolls as Houston and Florida returned to work. Last month saw a 0.5% average hourly earnings gain. Consensus is for 0.2% for October, but if this number stays at 0.4% or higher the interest rate markets will drop as yields rise. Of particular importance will be the 2/10 yield curve as it closed today at 74 basis points. A strong wage number should prompt a flatter curve as U.S. short yields will rise because investors fear the Fed will have to be more aggressive.

The unemployment rate is expected to hold at 4.2% and average work week expected to remain steady at 34.4 hours per week. This number is one of Art Cashin’s favorites for if this number drops it is equivalent to a job loss, while a gain would enhance the strength of the data. Sunday night I will have my views on the new Fed Chair, Jerome Powell. As always, be patient with the headline reads and have your lowest risk trading levels in place in order to take advantage of any drastic price swings as the algos race against themselves.

Tags: BOE, British pound, EUR/GBP, Mark Carney, nonfarm payrolls

This entry was posted on November 2, 2017 at 7:15 pm and is filed under BOE, Currency, data, United States. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.