V-E Day

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.

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Click here for comments
May 10, 2007 at 11:39 AM ×

I wonder if it could be profitable to buy sterling (the currency) just prior to the rate decision? Even though 50bps is extremely unlikely, it's a an outside possibility.

Here's my base case scenario for the sequence of events:

* 25bp rate hike delivered
* Mkt sells off a little, finding comfort from a qtr point hike vs residual fears of a half point rise
* Mkt rallies within minutes, as statement point to risk of another rate hike.

I would look to get back to break-even as sterling is bid back up, or higher, in this case. A riskier approach would be to add on the dip.

ps - I note quite a few commentators see risk of a GBP sell-off on 25bp...either way, it's interesting to work through the possibilities.

These are just my personal thoughts (not recommendations), and I have a tendency to lose money these days!

Macro Man
May 10, 2007 at 12:19 PM ×

Well, if you'd bought the second before the announcement and sold a minute later, you'd be quids in! Otherwise, the confirmation that prime minister Gordon Brown is comin' round the mountain in six weeks has now left you unched...

May 10, 2007 at 7:29 PM ×

yup, one minute too late and I would have been reeling! talk about arcade game trading