The return of Swervin' Mervyn

Well, it didn't take long for the governor of the Bank of England to remind us why he is known is some quarters as "Swervin' Mervyn." A day after Merv appeared to drop the hammer on bail-outs and "the world owes me a living" financial risk-takers, news has hit the tape that Northern Rock, a prominent UK building society, has borrowed "a substantial amount" from the Bank in an emergency operation.

As of yet, official details- the amount and the rate- have yet to be officially confirmed. That hasn't stopped the press from characterizing the operation as exactly what King stated would not be forthcoming: a bail-out.

Now, in his TSC statement, King did suggest that the Bank has a role to play as lender of last resort to ensure financial stability:

"In addition, central banks, in their traditional lender of last resort (LOLR) role, can lend “against good collateral at a penalty rate” to an individual bank facing temporary liquidity problems, but that is otherwise regarded as solvent. The rationale would be that the failure of such a bank would lead to serious economic damage, including to the customers of the bank. The moral hazard of an increase in risk-taking resulting from the provision of LOLR lending is reduced by making liquidity available only at a penalty rate."

The problem, of course, is that the current standard BOE "penalty rate", 6.75%, is actually lower than the current interbank borrowing rate. So conceivably, Northern Rock could borrow from the BOE and lend in the open market and lock in a small profit- exactly the sort of behaviour that King decried in his statement.

Macro Man is willing to withhold final judgement until the details emerge. But if NR really did borrow at the standard "penalty" rate just before announcing that a) they expect to earn £500-540 million this year, and b) they expect new lending volumes to increase, it will be difficult to avoid the conclusion that Swervin' Mervyn has committed the grossest hypocrisy. (Interestingly, there are a number of anecdotal reports of large queues outside of Northern Rock branches, so perhaps NR's cure was worse than the disease!)

Of course, puzzling behaviour is not confined to the BOE. Serial whingers the Swiss National Bank have provided numerous reasons to scratch one's head over the past few years, and this week is no exception. The SNB hiked its LIBOR target rate by 0.25%, surprising some observers but earning a hearty "Bravo!" from Macro Man. Yet this morning the SNB set the 1 week repo at 2.08%, a whopping 0.21% lower than yesterday. So on Thursday, they hike rates (fully justified, given their currency concerns), but on Friday they cut rates?!?!?! SNB: WTF?

The continued strength of equities, carry currencies, and other non-CP risk assets is also prompting Macro Man to ask WTF. We are swiftly moving towards a scenario wherein a 0.25% Fed easing will be seen not as as a disappointment, and thus a reason to sell stocks, but as a provision of unneccesary liquidity, and thus a reason to buy. Macro Man was filled on his sale of ESU7 at 1490, so if this scenario plays out he may be stuffed. That the central bank of Turkey felt sufficiently confident to surprise markets with a rate cut yesterday- which was followed by a rally in TRY- is pretty clear evidence that contagion risks have, for the time being, subsided. It's just another brick in the wall of Macro Man's view that a Fed easing would be a mistake.

Today sees the release of a really interesting piece of data in the US. No, not retail sales, industrial production, current account, or even consumer confidence figures. All of these will be interesting, to be sure, but the cyclical data is less significant than usual, as Big Ben noted last week, while the confidence data is, in the short term, little more than a proxy for the stock market. No, the figure that Macro Man is really looking forward to is the import price number.

Specifically, the figure on import prices from China. When Macro Man talks to his colleagues about inflation, articulating his view that it is a large and growing problem for the US, he draws a lot of quizzical looks. One tenant of his view that real-world inflation (as opposed to the core PCE deflator, a measure that nobody pays) is that the deflationary impact of the BRICS has been replaced with an INflationary impact.

As has been documented previously, US import prices from China are now rising y/y: 0.9% at last count. On a more high-frequency basis, the 3 month annualized rate is up nearly 3%. What's particularly interesting is that both the y/y and high frequency import price data bear a startling resemblance to China's headline CPI. All the more reason, therefore, to take the recent acceleration seriously and disregard thos analysts who seem to think that food prices don't matter. All of this, of course, is an argument in favour of allowing the RMB to appreciate more quickly. To a degree, this is occuring- against the dollar. EUR/CNY, on the other hand, is back close to its post-reval highs.

Regardless, if an acceleration of non-oil import prices is met with Fed easing, it provides another reason to question why anyone would buy dollars any more. While EUR/USD remains near all-time highs on a spot basis, at longer maturities (such as those used by some sophisticated European exporters), this is not yet the case. Might they start getting sucked in to take advantage of current "value" before long?

Perhaps, though Macro Man is wary of talking his book too much. (And Brad, to answer the question you asked in the comments section a couple of days ago: I'd actually prefer PBOC to bugger off entirely. But if they are going to screw around and set the exchange rates of countries whose capitals are not Beijing, I'd just as soon they did it in my favour than not!)

For now, Macro Man is now going to wait: wait to see how the equity dynamic plays out, wait for an oppounity to sell more dollars, and wait to see who is bailing out whom.