Bank of England curve-ball makes it a tough day on the beach...

 

ref:- "Volatile Bonds Are the Price of Unreliable Boyfriends", Bloomberg Opinion by John Authers, 5/11/21

First up, apologies to harking back to what may now be termed "old hat"... we took a break away last week and are still collecting our thoughts, but this piece by John Authers chimed so loudly with an episode on our trip that we had to indulge ourselves.

In our book, "away" means somewhere you need a plane to get to, so for the first time in what seems like decades we slightly nervously climbed aboard one in search of the last of the European pre-winter sun. We found it, too... which was nice, but you're never really "away" these days, are you?

On Friday morning the near-silent idyll was punctured when a classic trader-type appeared from nowhere to tell two friends (acquaintances? complete strangers?) how irate he was with Bank of England Governor Andrew Bailey and the decision of the BoE's monetary policy committee (MPC) the previous day NOT to raise UK rates, despite in the run-up to the announcement giving numerous pointers (some of them fairly direct) that they were likely to do so. Of course, he was actually telling everyone in earshot, which at a guess constituted everyone within a radius of at least 100 metres - old-style traders are not known for being shrinking violets and it's hard to imagine a louder office environment than a pre-pandemic trading room. In short, this guy was LOUD.

Like so many others expecting a move by the BoE that had seemed more than likely, this poor fellow had gotten himself long of sterling, very short of the shorter end of UK Gilts and a position in the yield curve likely to benefit from a counter-inflation hike in rates. Assuming he had got in early enough (and there was nothing to suggest that he wasn't pretty sharp), those positions must all have been looking pretty good too - only for those markets to reverse the large moves, ignited by the hawkish noises coming from BoE personnel, at the news of their surprise decision to sit on their hands.

NOTE: The MPC voted to do nothing, at least until the next meeting six weeks on, by a majority of 7 -2. Depending on your view, that either represents a "split", or a still-significant majority in favour of no action. Whatever the case, it's fair to say that a vote of 7 - 2 against does NOT accurately reflect the signals being given by MPC members before the decision.

Anyway, we were mildly amused by Traderman's performance. Not that we took any pleasure whatsoever in his misfortune, you understand... rather the opposite, in fact. It's just that in the past we have spent a good deal of time with traders just like him, and in the trading environment that we guess he inhabits. Generally speaking, we look back on those times, and most of the people, rather fondly. Sometimes a good stereotype can make you smile. But unsurprisingly most of the other holidaymakers slumbering in the sun were less impressed. The chapter was brought to a close when a doughty Englishwoman of a certain age and type made her feelings very plain and like the decent fellow he no doubt is, Traderman wandered off in search of a more distant, more receptive audience. Well, you would... wouldn't you?

There is a moral in this tale, and it's one for central bankers. Traderman may bang on about how the BoE's lack of action will damage the UK currency, which will itself increase upward inflationary pressure and mean that the BoE will have to act more forcefully in the future... which in turn will damage the economic recovery. That may or may not be true (though we note the bounce already evident in the aforementioned markets), but there is a wider issue here. We're talking trust and credibility in central banks, and how both are nurtured by the crucial communications they offer as "guidance". You really should read John Authers' piece that we have referenced, which gives a pretty detailed take on how the BoE's action (or lack of it) is in danger of undermining it's previously strong standing as an authority to be trusted.

Central banks have limited official mandates, which normally revolve around devising a monetary policy to manage an acceptable level of inflation and a high rate of employment. They have often said in the past that it's not their "job" to maintain high asset prices, which in theory is true but in practice is naive at best. Central bankers have in effect given up saying such things because of the volatility, even panic, that they provoke. Like it or not, they have inherited the unofficial but undeniable role of maintaining stability (which is not the same thing as maintaining high asset prices, much as some would like it to be). Some have put it that central banks no longer are just monetary authorities, but since the Financial Crisis and now the pandemic have to act as saviours of the world too. Of course they can't do it alone and need fiscal support from governments that until recently was so lacking. But as a guide to how crucial central bank actions have become' the "saviours" tag is far less exaggerated than it once was. Hence their communications, guidance and actions have to be in tune and reliable... and that's not what happened in the UK last week.

Trust is everything. As Mr Authers reminds us, central banks can and do use it to their own advantage... such as when they want to "jawbone" yields higher, for example. But it only works if they can be trusted. BoE boss Andrew Bailey's apparent indifference to apparent contradictions in his operation's recent words and actions raises the first questions about its credibility, and his joke about being a central bank governor entails acting like "an unreliable boyfriend" hasn't helped either. Traderman's personal losses may be nothing in the grand scheme of things, but if it becomes an example of a growing loss of faith in the BoE's credibility then the UK central bank will have a major problem.

Mr Bailey's got some ground to make up... and perhaps some serious thinking to do too.