Markets looked for direction Thursday and found little in the way of guidance until the US cash session, when upbeat data drove Wall Street to a fourth day of gains.
The dollar looks poised to become a stumbling block for the risk rally eventually, but “eventually” wasn’t Thursday.
There are some good reasons to expect a steady grind higher in US yields, and if that pans out, it could underpin the greenback, which is attempting a bounce after pushing to multi-year lows.
While not exactly an observation worthy of any accolades for outstanding achievements in profundity, dollar strength generally isn’t welcome when the world wants reflation.
The familiar, long-term “structural” dollar bear case is intact (bears claim it’s perpetually applicable, and cling to it like a Linus blanket), but obsessing over the “twin deficit” ghost story isn’t likely to be a fruitful endeavor if what you’re looking to do is forecast short-term, tactical moves.
In any event, the BOE was in focus Thursday, with an emphasis on the bank’s comments regarding the prospect of negative rates, which the Committee said it’s appropriate to prepare for if necessary. This is the culmination of a monthslong review into the viability of NIRP, and unfortunately, it’s necessary to take note.
There was a debate about the extent to which even asking banks to prepare for such an eventuality would invariably be construed as a signal that negative rates were coming no matter how carefully the message was conveyed. Nevertheless, it’s time to prepare for what could happen, but probably won’t, six months or more from now. That, in a nutshell, was the message. Below is the key passage from the February BOE minutes:
While the Committee was clear that it did not wish to send any signal that it intended to set a negative Bank Rate at some point in the future, on balance, it concluded overall that it would be appropriate to start the preparations to provide the capability to do so if necessary in the future. The MPC therefore agreed to request that the PRA should engage with PRA-regulated firms to ensure they commence preparations in order to be ready to implement a negative Bank Rate at any point after six months. The MPC understood that the PRA would make such a request by way of a follow-up letter to CEOs of PRA-regulated firms. The MPC also requested that Bank staff should commence internal technical preparations to deliver the option of a tiered system of reserve remuneration that could be ready to be implemented, should it be judged appropriate, alongside a negative Bank Rate. The MPC stressed again that these requests, and any subsequent related supervisory actions determined by the PRA, should not be interpreted as a signal that the setting of a negative Bank Rate or a tiered system of reserve remuneration were imminent, or indeed in prospect at any time. Monetary policy decisions would as always remain driven by the evolution of the economic outlook and the MPC’s commitment to meeting the 2% inflation target. The MPC would continue to work with the PRC and the Financial Policy Committee to enable them to assess the impact of setting a negative Bank Rate on the objectives of those two Committees.
Before you ask (yourself or someone else) that is indeed just as humorous as it sounds. Basically, the BOE is telling everyone to make any and all preparations for a negative rates regime, complete with tiering, while simultaneously insisting that nothing should be gleaned from that about the direction of policy.
Of course, contingency planning is a good thing. You don’t want to be unprepared. Still, the semantic acrobatics found throughout the February minutes are amusing. The passage (above) is indicative.
Six months appears to be the magic number when it comes to the absolute earliest that a negative Bank Rate could be imposed without causing some manner of disruption.
As far as the economic projections accompanying the February meeting go, the bank now sees the UK economy contracting 4.2% in Q1, and growing 5% for the year. That latter figure is down from 7.25% in the November forecast. Clearly, the virus is a risk, and the UK is still struggling with strict lockdowns. It even has its own virus variant, and more mutations are apparently showing up. “Public Health England is investigating cases of coronavirus with ‘worrying’ new genetic changes that have been found in some regions of the UK,” the BBC noted on Wednesday. “Tests show they have a mutation, called E484K, that is already seen in the South Africa variant.”
“The MPC’s central case projections for the UK are conditioned on an assumption that current COVID restrictions are in place until the end of 2021 Q1, before being eased over Q2 and Q3 as an increasing proportion of the population is vaccinated,” the BOE said Thursday, in its latest monetary policy report which, as usual, is nearly impossible to parse in real time.
“The uncertainty around how the pandemic might evolve – including the potential emergence of further new strains of the virus – and how government measures change in response, means that there are substantial risks around these assumptions,” the bank went on to say, before offering the following:
Different developments could have material effects on the paths of UK and global activity. As a result, the MPC judges that the outlooks for the UK and global economies continue to be unusually uncertain. Reflecting that, the MPC’s forecast fan charts remain wider than usual, particularly in the near term. The MPC judges that the risks around activity from pandemic developments are to the downside, although less so than in the November Report, and the risks are judged to be broadly balanced by the end of the three-year forecast period.
Forgive me, but that’s wholly laughable. If all you’re going to say is that different outcomes will affect economic activity differently and that uncertainty leads to wider fan charts, I’m not sure why bother in the first place. (There’s only so wide a fan chart can be before it becomes meaningless.)
Ultimately, the takeaway from the BOE Thursday was simply that the bank wanted insurance. They wanted the system to prepare itself for a negative rates regime even as they don’t intend to implement one, and definitely not in the next several months. “The latest decision from the Bank of England keeps the door open to negative rates, though only after a six-month period of industry preparation,” ING said Thursday. “But optimistic growth forecasts suggest that a foray into sub-zero rates is increasingly unlikely in the current cycle.”
Ideally, vaccination will proceed apace and fiscal policy can shoulder the burden of sustaining whatever bounce the economy manages to stage following the third national lockdown.
I realize all of that seems terribly dry, especially for readers outside the UK.
But the BOE has been around for a long damn time, folks. And a move to negative rates would be a historic moment. So the evolution of this conversation must be documented, as tedious as that most assuredly is.