- Market fails to push the EUR meaningfully lower
- BIS believes market is undershooting rate expectations
- Central Banks will have an impact next week.
European Markets ended Friday in a mild risk-off posture. There was no incentive for investors to do otherwise as the US equity and bond markets were closed due to the July 4th holiday.
In forex, the overall tone was quiet, but participants did try and push the EUR lower to extend yesterday’s post-payrolls dollar gains. Dealers and traders continue to use the time to debate whether central bankers in both developed and emerging economies were trying to talk down their currencies to make their economies more competitive.
The overall general sentiment remains: the world’s go-to currency of choice, the mighty dollar, is expected to be in demand by many. Especially with the Riksbank, Norges Bank, European Central Bank (ECB), Bank of Japan, Swiss National Bank and Reserve Bank of Australia all fighting for a weaker currency, the USD has nowhere to go but higher. The dollar bulls have been given a new lease on life and are feeling that the market is preparing itself for a sustainable trend higher for the USD.
Investors on one hand have to deal with “lower for longer” while on the other hand they are been told that they are “seriously underestimating” where official interest rates ought to be in a couple of years time if the BIS’s (Central banks Central Bank) calculations using the Taylor rule (effective way of calculating the level of interest rates consistent with trend growth and stable inflation) are to be believed.
According to the BIS, Fed Funds should be at +2.7% vs. +1.68% at the end of 2015. For the UK, the market is “undershooting” the Taylor Rule’s projection by a whole +2%. For the ECB it’s +0.7% and Japan +1.8%. Certainly a wide berth and if the BIS is considered the “golden” rule then all the major economies will be suffering from inflation problems within 12-months. If for nothing else, this will heighten market volatility as rate divergence speeds up. The knock on effect to the various asset classes should provide many opportunities for investors.
The skeptics will be relying on the potential inadequacies of the Taylor rule – it depends on estimates of potential output and equilibrium interest rates, both are subject to considerable debate.
Central banks are more concerned about deflation and believe that they have the time and knowhow how to reign in inflation. Overall, Central Banks would be hard pressed to change their current mandates too soon for fear of stifling current recovery. Despite job numbers catching the UK and Fed off guard, the slack in wages continues to be a concern as its difficult to pass on a positive effect throughout the respected economies. The slack in the market is reason enough for investors to trade under the “lower for longer” rule mentality.
On tap for next week:
Central Banks again take center stage next week. The FOMC meeting minutes appear mid-week. On Thursday, the BoE comes to the market with their rate decision and asset purchase details. The Aussie and Canada get to reveal their current job situation.
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