Regular followers of this blog can be forgiven for thinking I've been a little obsessed with interest rates in general and the Fed in particular for the last few weeks. Mea culpa, but I really think I in turn can be forgiven as a) interest trading is the sole preoccupation of my hedge fund, the C-View Global Macro Interest Rate Program, and b) in my very humble opinion, Fed QE 'Tapergate' is the biggest story in markets for just over four years and nine months.
Happily for you, dear readers, there are other stories on which we may ponder. Lest I roam too far from my interest rate obsession, first of all, China. Here, the last week has witnessed the application of a sharp 'smack on the wrist' for domestic banks, as the People's Bank of China, in a tactic no doubt sanctioned by government, allowed the overnight bond collateral repo rate to hit 13.8% on 20 June, up from 2 or 3% last month. This was designed to teach banks that unlimited liquidity was no longer going to be on tap, especially not to fund property lending. The PBOC has since injected a little more cash, but rates still remain elevated. Reports have filtered out that the PBOC has told banks it will provide them with liquidity if required, but only to fund 'real' lending to the economy, rather than for property speculation.
Coupled with the Fed's actions, this development is doubly significant, and spooked markets globally. The end of an era of unlimited, cheap liquidity seems to be drawing closer, and the implications of China's move may be felt nowhere more dramatically than in Australia. It appears China's administration is serious about much needed rebalancing, away from property development and investment generally, and into personal consumption. To me, that sounds like a recipe for less demand for the type of commodities which Australia produces.
Staying in the 'lucky country', this week saw Brutus, in the shape of Prime Minister Gillard, rather ironically slain by Caesar - former PM, Kevin Rudd. His own knife wounds having apparently healed, he was able to return the favour, stabbing her in the back, and thus becoming Prime Minister again. On balance, the detrimental effects of this upheaval upon the Australian Labour Party's chances of winning this year's general election will probably be cancelled out by Rudd's greater personal popularity with voters, and leader of the Opposition, Tony Abbott, will still enjoy a comfortable poll lead when the dust settles, ultimately winning the election. He is a somewhat controversial and divisive character within Australia, but we had a very successful PM of the same ilk a number of years ago here in the UK, didn't we? Knowing Tony very well, having been a college contemporary of his, I know Australia would certainly be gaining a man of unparalleled integrity, honesty, intelligence and patriotism. He also used to pack a mean punch, so watch out at the G20!
Wither the Aussie Dollar, given all of the above? China's rebalancing is a challenge and so is the fact that US interest rates may be set to rise earlier than we expected, with a concomitant negative effect upon Asian Emerging market nations (as yet to be quantified). All in all, I'd avoid the AUD vs the USD and, if you put my feet to the fire, I'd say we'll see the low 0.8's before we go back over parity.
Then what of Europe? Perhaps ludicrously, in typical fashion, the market had eyes for only one subject over the last few weeks, the prospects for Fed monetary policy, and, even more ludicrously, expectations for Eurozone interest rate rises grew, as they were caught in the downdraft of US markets. At one point, futures markets had started to expect that the ECB would have raised rates by 0.5% by next June. No way! The contrast stark between the fortunes of the Eurozone and the American economies will become ever more visible as this year progresses. ECB members have gone unheeded these last few weeks as they have reiterated that the ECB is technically prepared for negative Deposit rates, but as the dust settles on Fed policy changes, with the shock of the new gone, markets will again begin to contemplate an ever wider differential in interest rates, with very negative consequences for EUR/USD.