BoE has shown the way for the Fed

Outlook:

The Bank of England has shown the way for the Fed, even if we prefer to think the Fed “leads.” The BoE statement includes this little gem: “Although a large part of the cur-rent deviation of CPI inflation from the 2% target reflects unusually large drags from energy and food prices, core inflation also remains relatively subdued – a consequence of the past appreciation of sterling, weak global inflation and restrained domestic cost growth.”

Given similar data and the same global outlook, it’s hard to see how the Fed can avoid copying the same stance. Note that the BoE base rate is 0.50% and has been left on hold for 82 months.

We have two observations about the world today. The first is that blood is spilling out into the streets. That means the probability of an institutional failure is rising. You can have crisis conditions but no ac-tual Shock if institutions can hold it together. But as we saw with Bear Stearns and Lehman, and Long-Term Capital before those, it takes an institutional failure with pinball power to wreck the landscape.

Stay tuned for that one. The other thing about blood in the streets is that it’s the best time to buy. As soon as downward momentum fades and traders think they can discern a bottom coming, they will buy like banshees. The trick is knowing where to buy first. Weirdly and counter-intuitively, Goldman says big oil. A Reader wrote to us about Canadian Atlantic and Mexican real estate.

The other observation is the clear and frightening divergence between counties/regions. We don’t know how much a China slowdown affects Japan, but it’s not trivial. Yesterday Japan reported Nov machinery orders fell 14.4%, about double the drop expected, after a 10.7% gain in Oct. Year-over-year, orders rose a measly 1.2% when 6.3% was forecast and Oct had 10.3%. Machinery orders are always a volatile number and we probably shouldn’t go overboard drawing conclusions, but if we are seeking evidence for the global recession thesis, here is some.

Similarly, Germany is doing just fine with 1.7% growth this year and expecting 1.8% next year, while other eurozone members are struggling. Moreover, this is not all that far off the 2% the US is likely to get for 2015. The world leader for growth, according to Goldman, will be India, although the famously dysfunctional government is not really getting fixed, as so many had hoped of Modi (a crying shame).

In short, a multi-speed world. This leaves Germany and the US as world growth leaders—no reces-sion—while some others will get recession, including Japan and parts of Europe. What does this mean going forward? Barring an institutional failure that rattles around and through markets, it may mean a more data-dependent FX analysis plus even more focus on central bank attitudes. So far the Reuters re-port that five ECB policy makers oppose any expansion of QE, coupled with the Fed stuck where it is for months to come, is a form of stalemate. There’s nothing like expectations of central bank action to move the FX market. The absence of any such expectations means range-trading, possibly for a pro-longed period. Oh, dear. Right now it looks like the euro is trapped between support around 1.0809 (the recent low) and resistance around 1.0980.

Longer term, we need to watch those yields and how risk aversion, and the end of risk aversion when it comes, affects the differential. At a guess, the US yield can fall further while the Bund will stabilize, and that’s not dollar-supportive. We now think the possibility of an upside euro breakout is not as small as it seemed a week or two ago.

Before going off the deep end, we need to wait for whatever China is going to do next. It has to do something (doesn’t it?). We get a mass of new data next week but before China can expect us to take it in stride, we need institutional repair—both the stock market and the currency. Maybe we will get some news over the weekend. If not, the general overview would have the dollar benefit from continued strife. If we were to get some Chinese repairs, credible ones, look for some major improvement in the AUD most of all.