BoE's Carney Cannot Pound The Pound

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 |  Includes: FXA, FXB, FXC, FXE, FXF, FXY, NZDS, UDN, UUP
by: Dean Popplewell

Considering the news flow, which has been generally positive for risk, the forex market remains rather contained. This is nothing new; currency ranges have been controlled and handcuffed by central bank monetary policy for the past 18-months. Until there is a clear distinct break in global interest rates, central banks will continue to play the same tune. Investors lean heavily on guidance. With Ms. Yellen's first House testimony yesterday, the market was looking for any "chinks in the armor" on the handover from one Fed head to the next - it was a non-event. This morning the spotlight falls on the "Old Lady." Will the Bank of England disappoint? With Governor Carney at the helm, and under his brief tenure so far, he has not been able to disappoint capital markets.

The BoE believes the UK economy will grow faster this year than it previously thought but that interest rates will remain low for some time to come. Carney and his fellow policy makers have stepped away from tying the rise in its benchmark interest rates to the unemployment rate. It's no surprise that the BoE wants to take a broader look at the employment situation – using other indicators like the number of hours worked – to assess whether they need to tighten monetary policy. Focusing solely on the unemployment rate has blinded Carney and company on how well the UK economy is doing and giving the market the incorrect bullish rate message. UK unemployment rate is expected to hit 7% two years sooner than anticipated and it was to be the signal to hike rates. A tighter monetary policy now, by any developed country, would only stifle all the economic good up to this point. The BoE expects the UK economy to grow +3.4% this year, certainly a much quicker pace than the +2.8% predicted three months ago. With inflation remaining subdued, Carney can afford to keep current policies in place – interest rates are not expected to go higher than 2% or 3% for many years.

The BoE's inflation report indicates that the MPC still believes there is spare capacity in the labor market and that it represents between +1% and +1.5% of GDP. This leaves UK policy makers somewhat on the sidelines. If so, then there is no sense of urgency to adjust interest rates any time soon – lower for longer. The BoE's bullish tone has certainly trumped the markets less dovish rhetoric and provided sterling with a lift. Even the lack of a comprehensive overhaul to its forward guidance has not dissuaded the GBP bull this morning. The prospect of future higher interest rates makes any currency look attractive. It will eventually come, but not soon. The UK interest rate debate is all about "when they will hike" and not like the ECB's "looser monetary policy debate." Interest rate differentials favor a weaker EUR/GBP.

How did she do? Ms. Yellen's first testimony yesterday before Congress went as planned and allowed the rookie Fed head to hit all the high notes, pleasing most onlookers. The new Fed chair emphasized the need for more progress on the employment front. She did stress that the Fed's QE program is not on a pre-set course and that their monetary policy is expected to remain highly accommodative even as QE ends. Similar to her new colleagues from the G7, Yellen acknowledged the volatility in emerging markets, but so far she is not worried about it at least with respect to domestic policy. She also repeated that the Fed's tapering of its QE program is likely to continue. So by end of day yesterday, nothing had changed. It would have to take significant weakness in US economic data over a significant period of time to justify a shift in policy. All in all, it should be seen as a smooth transaction from one Fed head to the next.

Now that Fed Chair Yellen is willing to follow the Bernanke path of steady tapering; throw into the mix the US debt ceiling being suspended until March 2015 with a no strings attached (a clean bill), and it should have had more of a market impact. Not so it seems - the majors have been little changed, aside from GBP. Even China's surprisingly strong trade data overnight has brought a limited market response. It has at least calmed some of the market fears of a global and regional slowdown – which is always bullish for Australasian bourses.

It's not too much of a surprise to see Chinese data defy even the most bullish of market expectations. Earlier this morning, Chinese imports were up +10% year-over-year against +4% expected while exports rose +11% against a flat forecast. If anything, numbers like these lead to more questions. How accurate are they and is the market comfortable with them? Only a few should be able to answer that in the affirmative, especially with such a big miss. It seems rather convenient that when the market ever doubts the global economy, Chinese data comes up trumps. Despite this, China's widened trade surplus and continued capital inflows should show that the yuan remains under pressure to appreciate. Analysts expect the RMB to finally break that psychological 6.0 handle later this year.

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