The recent release of the latest FOMC minutes was fairly dull to be honest, but it did strike me as interesting that both the Bank of England (BOE) and now the Federal Reserve have commented about the complacency of investors regarding when hikes are likely to start. Janet Yellen noted “pockets of increased risk-taking across the financial system”, well Janet…. who’s fault is that? The more easy money there is washing around in the system the lower volatility is likely to be. And folks? Vols are pretty darn low in aggregate!
Regardless of who’s fault it is though, major central banks are telling us that we’re at the beginning of the endgame of this zero interest rate policy (ZIRP) world we’ve been living in. Whether it’s the 3rd quarter next year or the beginning of the year after, rates in major markets (Japan and Europe possibly excepted) need to start to go up. Markets and investing are obviously expectations based when in rational mode, but there’s the darker side of our collective consciousness which is dominated by greed and fear. Greed is definitely in the ascendancy right now, but if.. and this is what central bankers are worried about… the collective fails to properly factor in the end of ZIRP into expectations, we’ll get a negative surprise when the easy money disappears. When that happens fear will dominate and the mob is much harder to control or predict.
What can we take from this? I think markets need to have slightly more aggressive expectations of higher rates in the UK and US over the next 12 to 18 months. This will be a cushion for both GBP and USD. It doesn’t have to end in tears for risk. You can have rates going up and benign markets, as long as you have real sustainable growth.
Keep an eye on Japan. 2 months of ugly ugly machinery orders now. This is not good, yes it’s a volatile data point, but these are the core numbers that strip out the most volatile components. If you ever needed examples as to why QE may not be the panacea it’s cracked up to be, Japan is the perfect case study!
Anyway it would be unfair to pick on disappointing Japanese macro. Manufacturing data out of Italy, France and a few days ago the UK, hasn’t exactly been inspiring. We all want to think this phenomenon (poor manufacturing/ industrial production data) of the short term variety and not affecting the bigger picture macro. Too soon to tell. You’ll note I’m only mentioning today’s BOE monetary policy decision at the end of the blog. I really don’t see anything new coming from it and clearly the market doesn’t either, because GBP is not doing much of anything this morning!