The view upon return .... and it's a little different, for sure

Monday 21st March 2016

  

The view upon return .... and it's a little different, for sure

ref : - "Fed fuels inflation-proofed bonds rally" , The Financial Times , Companies and Markets

ref :- "Shades of Plaza Accord Seen in Barrage of Stimulus After G-20" , Bloomberg online, 17/3/16

Away for the second half of last week, and we've come back to a markedly changed landscape to the one we left. Actually, it would be more accurate to say a changed atmosphere rather than landscape as the actual monetary policy decisions reached by the five central banks we discussed last week went exactly as expected : the Norwegians dropped rates by 0.25%, everyone else remained where they were. But of course that's less than half the story ....

It's old news now but whilst the US Federal Reserve's "no change" decision was (almost) universally expected, the accompanying statement and insight into the Fed's current thinking most definitely was not. You may remember that we were contemplating last week how views might be changing. The market turmoil in January and February had led some to believe that rate hikes might be off the agenda entirely for 2016, but with the markets now largely recovered, the tight US labour conditions and the early signs of inflationary pressure had led quite a few to suggest that there might be 2 hikes on the way in 2016.

We didn't really expect that forecast to coincide with that of the Fed, however. Ever since the release of the "dot-plot" in December, which revealed that the median projection for rates of the individual members of the Fed's Open Market Committee was for 4 hikes this year, it's been plain that their median view has been a lot more hawkish than that of the market. With that in mind, it was thought that the new "dot-plot" released last week might be adjusted to show the likelihood of three rate-rises, but was unlikely to point to just two. In the event, just two hikes was exactly what they went for and even beyond that, Chairwoman Yellen and other officials struck a much more doveish tone in their rhetoric than might have been thought likely.

There's been something of a sea-change here, or at the very least a change of emphasis. The new, less hawkish stance has undoubtedly been inspired by further contemplation on what rapidly diverging interest rate regimes between the US and the rest of the world might mean : stronger dollar, capital flows out of emerging markets and an inability to service and repay dollar-denominated debt within them, global downturn impacting on the US economy etc etc. All of which is perfectly valid of course. It's just that up to this point the Fed has gone out of its way to be seen as being "ahead of the curve" on the inflation issue. In other words, being more hawkish on rates to keep inflation below the 2% target.

That position definitely looks to have changed. From what we're hearing, the Fed is now more concerned with the possibility that US growth might stall than the narrow requirements of keeping a lid on domestic inflation. Which is to say that all of a sudden they'd be no more worried about a modest overshoot in inflation than they currently are about an undershoot. This new, laissez-faire attitude and the prospect of a slower upward projection for US rates has provoked predictable market reactions : weaker dollar, equities higher and a boost for bond markets in general and as the FT points out, TIPS in particular. Remember them ? Treasury Inflation-Protected Securities ? If you believe that the Fed has taken a more relaxed stance towards rising inflation, then it follows that these are the ones to be in.

And just quickly ....

Talking about a lower dollar, and because we like to ponder the efficacy of currency agreements, we were happy to stumble upon a Bloomberg piece that informed us that two of the big boys at PIMCO, one of the world's leading asset managers, reckon that the G-20 meeting in Shanghai last month may in fact have been less of a damp squib than it seemed at the time.

You'll recall that in advance of the meeting there was a fair amount of speculation that central banks might get together to coordinate a plan to stabilise the dollar (ie put a lid on it), something similar to the 1985 Plaza Accord where a deal was struck to bring down the value of the rocketing US currency, particularly against the Jap Yen. Two years later of course, the Louvre Accord was struck to bring things back the other way.

We said in advance of Shanghai that such an agreement was extremely unlikely, and indeed officials said that nothing along those lines was even discussed. But the suggestion from PIMCO now is that whilst those earlier accords achieved their goals through coordinated intervention in foreign exchange markets, this time there has been a secretive deal to keep the dollar down through monetary policy. If the main driver of dollar strength has been divergent interest rates (US up, everywhere else down), then central banks have been acting in such a way to soften the effect of that divergence.

The evidence offered points out that in order to boost growth authorities such as the ECB and the Bank of Japan have cut headline rates less than they might have and indulged instead in increasing credit expansion through measures like corporate bond purchases. At the same time, the US Fed has now adopted a much slower path of raising rates. Net result ? Weaker dollar....

Frankly, not many will buy into the theory of a secret agreement. That said, it should be remembered that central banks DO talk to each other and will be aware of what their counterparts are doing. Currency levels will always be part of their considerations and in the case of the US Fed, their decisions will have profound effects on the global economy which in turn will effect the domestic one. Seen in that light, it's not a total surprise if an element of "big picture thinking"is perceivable.