How central bank inaction turns to action in currencies and what's next for markets


The Federal Reserve has sent the dollar up, while the Bank of England has triggered a downfall of the pound. Neither changed nor committed to imminent action. What is going on? Valeria Bednarik, Joseph Trevisani, and Yohay Elam discuss the latest moves in markets, touching on other topics as well, and looking ahead to the next moves.

Yohay Elam: A slew of central banks have announced their decisions. While none have changed their policies, their guidance moved markets. Let us start with the Fed, the world's most powerful central bank. The Fed signaled no rates hikes through 2023

Valeria Bednarik: Yeah, extended forward guidance a year... I'm not sure it the market took due note of that. If the dollar was weak ahead of the meeting, this extension of the forward guidance with rates on hold for longer, should have quite a negative impact on the greenback, despite the initially spurred risk-off backing it

Yohay Elam: So, dollar strength is due to positioning prior to the event?

Joseph Trevisani: I'm convinced the only reason the Fed added the extra year to its projections so that it could extend guidance without terrifying the markets by making its 'longer run' category 0.1%

Valeria Bednarik: And a bit of disappointment? after Retail Sales we were all thinking the Fed was ready to pump more. Stocks and gold didn't like the moderate optimism from policymakers.

Joseph Trevisani: Retail sales for August missed expectations but the six month average in sales at 0.87% and control at 1.28%, including the shutdown months of March and April is the best half-year in a decade and more.

Yohay Elam: I pin it on sensitive stock markets. After the rally in August, they began falling and remained vulnerable.

Joseph Trevisani: It's hard to see in the Covid-19 miasma

Yohay Elam: Without imminent Fed action – Powell said the current level of QE is appropriate – stocks suffered and the dollar advanced on safe-haven flows

Valeria Bednarik: Yeah, however, is this rally sustainable? I don't see it yet

Yohay Elam: The excellent retail sales are a result of fiscal stimulus. When it lapsed, sales missed estimates

Joseph Trevisani: Perhaps, but the economic impact is the same whether it is stimulus money or wages. In normal times, a 0.6% monthly gain in sales would be a good performance

Valeria Bednarik: It's difficult, everything is hanging by a thread. Stimulus, growth, inflation, employment, etc. It seems all is "balanced" at the hedge of a cliff. And winter is coming...

Joseph Trevisani: Have you been watching Game of Thrones?

Valeria Bednarik: I mean, it does not even worth mentioning the uncertainty we keep on living in, and that central bankers don't ignore. I don't "watch," I read 

Joseph Trevisani: Winter is coming is the famous line...

Yohay Elam: I haven't seen a single episode but I'm very familiar with that line

Valeria Bednarik: Yeah, I know. What I mean is that with the virus far from under control, and cold temperatures returning, respiratory illness increase, and so will COVID-19, hence uncertainty

Yohay Elam: Uncertainty was the Fed's main message

Valeria Bednarik: All central banks' main message

Joseph Trevisani: Uncertainty is not something the Fed can cure.  I'm not sure that it should try.

Valeria Bednarik: But it has to cope with it

Joseph Trevisani: Central banks have essentially one tool, interest rates. Having one tool they use it in all circumstances, appropriate or effective or not

Yohay Elam: It tries to remove uncertainty about rates by committing to long term low rates. It cannot control the health crisis nor fiscal stimulus

Valeria Bednarik: Agreed

Yohay Elam: I think Powell said they are applying "very strong forward guidance" or something along these lines

Joseph Trevisani: I don't think there was much market uncertainty about rates nor did extend it one year change very much. Currency markets have a far shorter horizon. Hence, the lack of market reaction.

Yohay Elam: Indeed, the interest rate in 2023 does not mean much to the dollar this week

Joseph Trevisani: It does not

Yohay Elam: "Powerful," he said

Joseph Trevisani: Any idea what 'powerful' guidance is?

Yohay Elam: I guess it means a long-term commitment, but I'm not sure. Easier to understand than "passive intervention"

Joseph Trevisani: So the Fed is married to zero rates.

Yohay Elam: A Catholic marriage or at least no divorces allowed in the next three years... Less than 24 hours after the Fed, the BOE had a totally different message

Valeria Bednarik: The BOE has to deal not only with the pandemic but also with Brexit. And PM Johnson is not making it easy, but yeah, the message was more dovish. And just the mention of negative rates put traders on the run.

Yohay Elam: I am still perplexed by the rush to negative rates. I cannot say it is a success story in the eurozone, nor Japan. The only advantage is weakening the pound

Valeria Bednarik: Indeed

Yohay Elam: At least that provides more volatility than strong forward guidance, which tells traders to look away from the Fed...

Joseph Trevisani: Never underestimate the bureaucratic imperative. Rates are the banks' only tool. Negative rates are a logical extension, no matter how illogical they are in reality.

Yohay Elam: I guess we humans feel more in control if we do something rather than sit on our hands

Joseph Trevisani: I think the psychological message from negative rates is one of permanent weakness, it drains the energy needed to take risk, and private sector risk is the driver of economic growth. Though in more than a few cases, inaction is the best course.

Yohay Elam: Inaction might be better indeed. In the Fed's case, inaction may help push lawmakers strike a deal. The same logic should apply for the eurozone and the UK

Joseph Trevisani: Yes, and it will keep the Fed from the zero rate trap

Yohay Elam: At least in the UK

Valeria Bednarik: As you said, Yohay, inaction didn't probe to be effective in Japan or the EU. I do agree Powell's intention may have been to put pressure on lawmakers

Joseph Trevisani: In the US election, politics is the controlling issue.

Yohay Elam: I think that politicians are reading the data as well

Joseph Trevisani: Another stimulus will help the economy and an improving economy will help Trump, thus no deal.

Yohay Elam: I disagree. Democrats passed a huge stimulus deal in May

Joseph Trevisani: Ha, I thought you might

Yohay Elam: Republicans wanted a smaller one. Republicans reduced their offer following the strong NFP

Joseph Trevisani: In May, the economy was in dire shape and the election was far, both reversed now.

Yohay Elam: And may now be willing to upgrade it after the retail sales. Had the GOP gone along with Dems like in the CARES act, the economy would have been doing better, improving Trump's chances. Elections are not only about the economy though, there are so many other factors

Joseph Trevisani: I would like to agree but for the next two months, everything is about the election.

Yohay Elam: As a politics junkie, I hope you're right... But central banks have been moving markets. We had the dollar up on the Fed, the pound down on the BOE, the euro up on the ECB, and unfortunately for the poor BOJ, no reaction in the yen from their decision... Do you think markets will now ignore central bankers?

Joseph Trevisani: Not entirely, it's becoming the law of small differences.  Actually the original phrase is the narcissism of small differences.

Yohay Elam: We are going to get speeches from Powell, Lagarde, Bailey, and colleagues

Joseph Trevisani: Even though the actual rate differences between the central banks are trivial in any economic sense markets will still note and move because there is little else. CB policy is established.  Fiscal policy can add or subtract at the margins but the central fact is the virus or the government response to it. Still, there are topics that can scare markets, negative rates are one. We saw that today with the sterling.

Yohay Elam: The BOE used to be a non-event. While negative rates are not useful at all for the economy, they are useful for traders...

Joseph Trevisani: Yes, traders are agnostic

Valeria Bednarik: However, the MPC only discussed it. There is no other sign that they may use such a tool. It seems rather a way to spook bulls and kept the Pound from appreciating

Joseph Trevisani: Good point, though I wonder if the MPC is that cynical

Valeria Bednarik: Policymakers have sent messages against currencies' appreciation. RBA´s Lowe said it last week. ECB also...

Joseph Trevisani: Yes, they have

Yohay Elam: Bailey risks being the boy who cried wolf, but for now, he has a lot of credibilities to burn through, and the minutes are edited, someone or some few chose to include the reference

Valeria Bednarik: Anyway, that's the most they can do. Send messages. We all can remember strepitous failures on interventions some years ago.

Joseph Trevisani: The glory days of direct central bank currency intervention are history.

Valeria Bednarik: Yes, they are

Yohay Elam: But they are memorable (SNBomb)

Valeria Bednarik: Yes! we all thought about that

Joseph Trevisani: Currencies have been stalled for more than a month now. What might it take to get the dollar moving?

Valeria Bednarik: I don't want to say it.

Joseph Trevisani: An unequivocal US recovery might, even though the Fed is on hold, apparently until well past my retirement, which, by the way, is not imminent

Valeria Bednarik: Guess that has more chances of happening once the pandemic is over

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