Thursday, July 05, 2007

Belt tightening

The first Thursday of the month is generally busy in Europe, as that is the day when the Bank of England and the ECB (excepting August) announce their interest rate decisions. Today, the BOE is expected to put rates up by 0.25%, while the ECB, via Jean-Claude Trichet's annoying series of code words, is expected to signal a rate rise when it comes back to work in September.

The dollar continues to trade poorly, and once again it would probably be foolhardy to ascribe too much in the way of tectonic fundamental shifts as the catalyst. Simply put, someone is selling it; therefore, it goes down.

Insofar as fundamentals are driving currencies, markets seem fairly happy to discount further rate rises in Europe while forecasting unchanged rates at best in the US. All well and good. However, there seems to be little sense in Europe that rates are restrictive; indeed, the ECB has gone out of its way to state that they view rates as remaining on the accommodative side.

How they arrive at such a conclusion is difficult to say, unless they use money growth as their primary criterion. Short rates are right at their post-unification average in Germany and well above their ten and fifteen year averages. Moreover, it is also clear that some interest rate-sensitive economic sectors in Europe are beginning to feel a pinch- perhaps those belts have been tightened more than central banks realize?

Ireland, while a very small economy, is useful as a leading indicator as it has both a floating rate liability profile and a penchant for housing speculation/accumulation. And the news there is far and away from suggesting that rates remain accomodative. Nationwide house prices are rising just 2.6% y/y, well off the recent peak and approaching the nadir established after the dotcom bubble burst. A report (sadly unavailable in linkable form) from Davy stockbrokers suggested that housing registrations (akin to permits) fell 61% (!!!!!) y/y in May, unsurprisingly the worst reading on record. If that's a product of accommodative policy, look out below when rates get restrictive!
The UK, meanwhile, has a dirty little secret: a distressed subprime underclass of its very own. While early action from the regulators will almost certainly head off any US style subprime credit crunch, Macro Man looks around him and wonders when the economy will hit the wall. Certainly the horrible weather suggests significant downside risk for retail sales in June (albeit with a catchup in July as the sales get frontloaded); what will happen when 2 year fixed rate mortages (taken out in 2005) get reset in Q3 and Q4?

There's no trade here and now, and Macro Man of all people knows the folly of standing in front of Voldemort when he has a EUR/USD axe to grind. Perhaps we are in the midst of a range adjustment, from 1.33/1.37 to 1.35/1.39. But the vehemence of the move, combined with virtually no discussion/discounting of when European rate cycles might end, are forcing Macro Man to scratch his head and, by and large, sit this one out.
As an aside, does anyone out there know what the hell the Central Bank of Russis is up to? They revalled the RUB versus its basket last week, but have subsequently let it drift back and retrace more than half of the revaluation. This comes in stark contrast to the behaviour around previous revals, as the chart above demonstrates. Meanwhile inflation data for June revealed a much stronger than expected 1% m/m rise in June, thereby threatening CBR's year-end inflation target. Not the most obvious environment, then, to screw around with the RUB....


Econocator said...

Hi Macroman, thinking about the weaker USD and Fed policy it would seem the market is more certain of the policy path of the BoE and the ECB, and more uncertain re the Fed (i.e. the range of forecasts is more dispersed), and perhaps this uncertainty warrants a slight cheapening of the USD. Any idea if this can be measured from the options market?

Macro Man said...

Well.....implied vol of the eurodollar strip IS higher than than of euribor or short sterling, so that would suggest that something of a risk premium is attached to the US monetary policy trajectory.

That having been said, the implied volatility premium in eurodollars has actually fallen recently, so there's not much to suggest that that has been the driver of recent dollar weakness.

Anonymous said...

Re: the Irish housing starts.
It was suggested that maybe the figure is somehow election related. In late May the government promised changes in stamp duty if they won the election, so buyers went on hold waiting for the changes...

Macro Man said...

Yeah, that might have an impact I guess...but I thought there was no stamp duty on new builds in Ireland priced at under €500k? Or are Irish dwellings under half a mill an extinct species? (I know they are in Dublin, but thought the rest of counbtry was slightly less ludicrously priced)