Forward Guidance Fills Policy Uncertainty
City Index August 1, 2013 9:14 PM
<p>Today’s release of 326K in US jobless claims (lowest since Jan 2008) and the 55.4 reading in July manufacturing ISM (2-year high) must both be […]</p>
Today’s release of 326K in US jobless claims (lowest since Jan 2008) and the 55.4 reading in July manufacturing ISM (2-year high) must both be added to the 6 reasons the Fed should taper asset purchases in September, published in yesterday’s piece.
Forward Guidance Fills the Void
As central banks run out of tools (zero interest rates), the dependence on words and semantics has increased as a means to improve central bank communication to markets and the media. Forward guidance, a communication tool aimed at clarifying the policy on interest rates (or asset purchases) with the use of time frames, a specified date or a data threshold.
The ECB’s forward guidance refers to interest rates remaining low “for an extended period of time”, while the Fed has a guidance for rates remaining low “as long as the unemployment rate remains above 6.5%” and a guidance for maintaining asset purchases “until the outlook for the labor market has improved substantially in a context of price stability”
This leaves out the BoE. The only bit of forward guidance from Carney’s BoE has been the indication that current gilt yields were too high. That is not enough. Carney will have to introduce an additional policy objective besides the 2.0% inflation target. UK annual inflation has been above 2.0% for nearly 4 years. Despite halving inflation to 2.2% last autumn, the BoE has yet to meet its mandated target. At next week’s inflation report, we expect Carney to introduce growth-oriented targets, such as employment metrics or loans to the private sector, enabling the Monetary Policy Committee to stimulate hesitant growth without focusing attention on a single price target at the expense of sacrificing vital growth. As long as Mr. Carney insists that inflation will recede back towards 2.0% and uses terms such as “escape velocity”, bond traders can be assured that monetary policy is far from “maxed out”.
The above analysis further supports our preference for EURGBP, as it breaks out of its 4-year channel to attain the next objective at 0.8880. EURUSD bides its time below a key resistance of 1.3440s, before it’s expected to chart a gradual pullback to 1.2970. The euro’s next focal point could well likely be the Fed’s annual symposium in Jackson Hole, Wyoming (late August), which is likely to shed further clarity on the race for the next Fed Chairman and Janet Yellen’s latest read on the economy from her widely anticipated speech at the conference. We would expect President Obama’s preferred candidate Lawrence Summers to have made is part of lobbying to Congress and the media by that time.
GAIN Capital UK Limited (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.
No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.