Paymasters Beware, A Call to Arms

 

A National Bestseller or is it?

 

The move by the Swiss central bank on Thursday January 15th that we detailed in last week’s dispatch, to give up its peg against the euro looks to have been a seminal moment in the currency war as the race to the bottom by global central banks is back on. There has been a call to arms since the Swiss move with no less than nine central banks making moves. Six central banks surprised the markets with an interest rate cut – Canada (http://bit.ly/1yHJaII), Denmark, Egypt, India, Peru, and Turkey. South Africa’s central bank surprised the markets with a strong shift from neutral to dovish tilt. The central bank of China added stimulus via liquidity injections and the ECB unleashed its long awaited QE which will inject about €60 billion per month until September 2016.

 

The ECB’s move received the lion’s share of the media coverage given that it is one of the three most prominent central banks next to the BOJ and the Fed.

 

 

We took an informal survey on the trading desk asking the dealers which currency they thought was the worst performer for the week and overwhelmingly they all thought that the euro was the worst performer. As you can see from the performance chart, the euro was in the middle of the pack – that’s what media headlines do, they shape your opinion. The euro was in the middle of the pack because much of what the ECB was already priced in while the move by the Bank of Canada was a much bigger surprise to the markets. Notice how the worst performers were the AUD and NZD and they didn’t make any monetary moves. Speculators sold down the AUD and NZD because they expect that Reserve Bank of Australia and the Reserve Bank of New Zealand will respond in a similar way. The market is now pricing in two rate cuts by the RBA in 2015 and they expect that the RBNZ will give up its hawkish position and keep rates on hold.

 

 

 

Why are these central banks easing monetary policies? In a single word: deflation. Look at the weekly chart of the CRB index, which represents 28 commodities. It has now fallen to a level not seen since 2009. Central banks fear deflation; it is a lot more difficult to deal with then inflation. This makes perfect sense as you can always raise interest rates and curtail monetary stimulus to combat inflation but what do you do when you can’t cut interest rates anymore to fight deflation. We’re afraid that the real answer is that central banks can’t fight deflation because it is caused by the lack of aggregate demand. In our opinion, the lack of aggregate demand is best addressed by letting the capitalistic system work – let companies fail to find the equilibrium. If central planners insist in addressing the lack of demand they should give money directly to the public instead of giving it to the bankers via QE – it seems obvious that the trickle down effects of QE hasn’t been able to boost inflation. Giving funds directly to the public will cause them to spend it thereby spurring inflation.

As more central banks ease monetary policy, the hawkish bias of the Fed will make the USD more attractive to global investors. This week’s Fed policy statement on Wednesday will be scrutinized for any subtle changes. The market will be looking to see if the Fed telegraphs any change in the timing of its first rate hike. Any change that pushes the rate hike further out would give the market a reason to sell the USD. Until then, look for the USD to continue to push higher against all currencies.

 

How much higher do you think the USD will go? Leave us a comment below!