Thursday, May 10, 2007
Today is V-E day in financial markets. What's that, you say? You thought V-E day was on Tuesday? For those older than 63, it was. To those in the coalface of modern finance, however, today is V-E day. That is to say, vigilance in Europe day, as ECB governor Trichet is widely expected to use the V-word in his press conference today, thereby signalling a rise to a 4.00% refi rate in June.
The Bank of England at noon London time may prove to be more interesting, however. The dilemma facd by the Bank was in many ways encapsulated by today's data releases in the UK:
* Halifax house prices rose 1.1% in April, more than expected
* Industrial production was weaker than expected and has turned negative y/y
* The trade deficit was much wider than expected, reflecting strong domestic demand and the absurd overvaluation of sterling
What to do? A rate hike seems like a done deal, but further aggressive tightening risks a further appreciation of sterling, which would amplify macroeconomic volatility in the future. Doing nothing would send the wrong message to lenders. Macro Man has spoken to some people who expect 50 bps and some who think they could do nothing. The UK press appears to be rooting for a one and done (clearly, financial journos all have mortgages!) The BOE's course of action really depends on which economic outcome they are most concerned with- inflation (high, but forecast to fall sharply), asset markets (robust, but not fully reflecting prior rate rises), the real economy (fairly robust but with some pockets of concern) or the external balance (deteriorating rapidly.) Base case is for 25 today and leaving the door open for further tightening, though the Bank is unlikely to leak too many details of next week's inflation report. Macro Man will use any relief rally in short sterling to exit his long, as his conviction that 5.75% will be the absolute top (and indeed, that the trade will still make a small profit with rates at 5.75%) is wavering.
The Fed and the currency manipulation hearings were largely non events. More later, including some thoughts on interesting trades, after the CB hoedown.