Fed: Data Shows Mkt Pricing in Q2 Rate Hike?

It has been a while since I provided updated numbers for the market’s rate hike expectations and I will chalk it up to my travels! Rate expectations are always changing and a lot has happened over the past month. Its always important to keep track of them because they reflect what investors are pricing in!

Here are the latest numbers and highlights (compared to March)

Fed – One 25bp rate hike expected by Q2 2012 > Compared to Q1 rate hike before
BoE – First Rate hike expected in Jan > compared to prior forecast for 50bp rate hike in 2011
ECB – 50bp of additional tightening expected > compared to 75bp after April hike
RBA – Close to one 25bp rate hike by years end > significant upgrade from March expectations
RBNZ – One rate hike in Jan 2012 > bumped up from March
BoC – 25bp rate hike in Oct > slight downgrade in rate hike expectations

New BoE Member Broadbent: What’s His Story?

At the end of this month, the Bank of England will add a new member to their Monetary Policy Committee – Ben Broadbent. He will replacing Andrew Sentance who has voted for an interest rate hike since the beginning of the year. Sentance was the most hawkish member of the MPC, having just voted for a 50bp hike earlier this month. His departure will leave the central bank with a less hawkish bias. As a new member of the MPC that joins the BoE at a critical turning in point in monetary policy, it is important to understand as much as we can about Ben Broadbent.

· Mr.Broadbent is the chief European economist at Goldman Sachs

· Gained a first-class honors degree from the University of Cambridge

· Received his Ph.d from Harvard University, where he was a Fulbright Scholar

· Worked previously for H.M. Treasury, the Bank of England, and at Columbia University as an Assistant Professor

· Joined Goldman Sachs in 2000 as Senior European Economist; Became MD in 2006

· Mr Broadbent, who has worked for the Treasury and the Bank as well as in academia before joining Goldman in 2000, was appointed by Chancellor George Osborne after being interviewed by a panel including the Treasury’s Dave Ramsden and Tom Scholar as well as former MPC member Kate Barker. He was chosen from 27 candidates.

· Mr Broadbent will be paid £131,771 – £101,362 in salary and £30,409 as a pension supplement. This is less than he is thought to have earned as a Goldman managing director

· He will join on June 1 and make his first decision on June 9

· Broadbent has indicated in recent notes that he would support rate rises from the current historic low of 0.5pc, but is not as committed to action as Mr Sentence

· Mr Broadbent’s research at Goldman suggests he is upbeat about UK growth for 2011

· His thoughts on Rate Predictions:

“Last week, we brought forward the first hike in our forecast from Q4 to May. We now expect one 25 basis point increase per quarter through to end-2012.”

· His thoughts on Growth Outlook:

“The composite PMI remains consistent with growth of around 3pc quarter-on-quarter annualised in private-sector non-energy output, however, and this should allay some fears that the contraction in Q4 is representative of underlying trend activity. If we also adjust for the sterling price of oil, which has risen by around £7.50 per barrel since January, the composite PMI remains on the cusp of rate-hike territory.”

· His thoughts on Wages:

“The January data suggest wage growth is less disinflationary rather than more inflationary. But the trajectory of settlements over the coming months may soon look steep enough to turn the doves on the MPC.”

· In a note published on Monday, Mr Broadbent said a May rate hike would depend on whether first-quarter growth showed the strength implied by private sector surveys and whether private sector wage settlements pick up

· Broadbent has said that whether the BoE will raise rates depends on first-quarter growth living up to the expectations of a sharp rebound and private sector wage deals picking up further

From May 17th, 2011 Testimony to the Treasury Select Committee
· He said the effect of QE on the economy was “hard to gauge”, although he said it was “hard to imagine there’s been no impact”

· Mr.Broadbent ruled out the need for more QE, and appeared to downplay the need for immediate policy tightening

· He expected inflation to fall next year, broadly along the lines of the MPC’s forecast

· He said it was important for policymakers to monitor a range of indicators of inflation expectations, but that he saw no strong evidence that expectations had become de-anchored from target

· Mr Broadbent noted three main Downside risks to the economy:

o a sudden rise in household saving

o higher commodity prices (which would squeeze real purchasing power)

o higher bank funding costs from financial market stresses

· He said it was important for policymakers to monitor a range of indicators of inflation expectations, but that he saw no strong evidence that expectations had become de-anchored from target

· Initially, Mr.Broadbent was expected to be towards the hawkish end of the committee

· However, he might not be supportive of early policy tightening according to his testimony today, in which he highlighted

o downside risks to activity

o a lack of concern about inflation expectations

o & confidence that inflation will fall back towards target

Forex: Major Changes to Rate Hike Expectations

Over the past 3 weeks, central banks around the world have made a number of comments that have affected rate hike expectations. On Jan 27th, I showed where rate hike expectations were at the time and since then a number of interesting changes have occurred.

First, the market is now pricing in a 25bp rate hike by the Fed in Dec. Last month, no rate hike was expected. Close to 70bp of tightening is now expected from the Bank of England, up from 50bp. The market went from pricing in 2 rate hikes from the Reserve Bank of New Zealand to one. The European Central Bank and the Bank of Canada are now expected to tighten by 75bp this year instead of 50bp. A lot can change in 3 weeks =)

Chart: BoE Inflation Report Rarely a Nonevent for GBP

The Bank of England’s Quarterly Inflation Report is one of the most important pieces of documents released by the central bank. The Inflation Report includes the central bank’s latest growth and inflation forecasts and frequently telegraphs their plans for monetary policy. Although the Monetary Policy Committee has not changed interest rates in nearly 2 years, they getting close to raising rates and because of that, investors are watching their every move.

The publication of the Inflation Report is rarely a nonevent for the GBP/USD. The following chart from Barclays Capital shows the rollercoaster like reaction in the currency pair days after the report is released. With the Bank of England upgrading its inflation forecast and downgrading its growth forecasts, sterling traders are as confused as ever and this confusion could turn into volatility for the British pound. The sell-off in the GBP/USD today indicates that the Quarterly Inflation Report was not nearly as hawkish as investors had hoped but many economists are still looking for the BoE to raise rates this year. In the short term, the less hawkish tone of the report could lead to additional position adjustments in the GBP but in the long term, the GBP is still headed higher because the BoE remains at the verge of raising interest rates. There is no question that the U.K. central bank will tighten before the Federal Reserve.

What is the Shadow BoE Monetary Policy Committee?

Since the beginning of the month, the British pound has staged a dramatic rally against the U.S. dollar on the belief that the Bank of England will have to raise interest rates very soon. In slightly more than a month, the GBP/USD has rallied from a low of 1.54 to a high above 1.6250. Interest rate futures show that investors are looking for 3 quarter point rate hikes from the BoE this year, which would make them one of the most aggressive G7 central banks. However this hawkish expectation from investors is completely at odds with the sentiment in the Bank of England. Monetary policy makers are convinced that the rise in inflation pressures is temporary and therefore does not necessitate action by the central bank. However two members have already dissented from this majority view and more could follow.

The Bank of England’s monetary policy is in focus this week because they have a monetary policy meeting but no changes are expected to made. However the pound has held onto its gains after the Shadow Monetary Policy Committee voted 5-4 to raise interest rates in Feb. At this point, you may wonder, who makes up the Shadow MPC and whether they even matter at all.

The Shadow Monetary Policy Committee (SMPC) is a group of independent economists in the U.K. that meet at the Institute of Economic Affairs, to discuss the state of the international and British economies. Their first meeting was held in 1997 and have met once a month since then. The decisions and minutes of the SMPC are published a few days before the Bank of England’s own interest rate decision and are oftentimes referred to as a guide for what the MPC could do. Like the Monetary Policy Committee, there are 9 voters at each meeting.

For the first time in this cycle, the Shadow Monetary Policy Committee has voted to raise interest rates. The decision was not unanimous with 5 members voting for a rate hike and 4 voting against it. Although the shadow council failed to predict the last 2 rate cuts by the MPC, their decisions matter because it helps investors get a sense of what intelligent economists who follow the U.K. economy closely are thinking. According to the SMPC, there were 3 main reasons why the 5 members voted for a rate hike:

1. Threat to the Credibility of the Inflation Fighting Mandate of the Central Bank

2. They believe that the greater risk for the global economy is overheating than depression

3. They believed that the slide in the GBP reflected the laxity of the U.K.’s monetary policy compared to other countries

Although the chance of the BoE actually raising interest rates is slim, what the SMPC votes tell us is that we are getting closer to a possible rate hike. This means that hawkish comments from central bank officials could easily set off additional gains in the GBP/USD that could cause the currency pair to challenge its November highs.