Is Now The Time To Raise Rates?

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By Mike Conlon | July 6, 2011

That’s the question some are starting to ask now as the market has fully priced in a 25 bp rate hike from the ECB for the Euro zone tomorrow. This comes after yesterday’s downgrade of Portugal’s debt to junk status by Moody’s who are concerned that another bailout may be required.

This also comes after the issues of how to solve the longer-term Greek debt crisis are going to unfold and how a solution is going to be reached without creating a credit event. So far every plan that has been floated has been seen as creating a credit event. Despite these problems, German factory orders came in much better than expected, posting an increase of 12.2% vs. an expectation of 9.5%.

The BOE is also set to decide on interest rates, and though they are expected to remain unchanged, home prices came in last month showing a gain of 1.2% vs. an expected no-change which could add to the inflationary pressure the central bank is ignoring.

A little earlier this morning, China raised interest rates another 25bp in an attempt to slow down their economy, which put immediate pressure on the oil market and risk appetite in general.

Here in the US, job cuts figures increased, meaning there were more plans to fire rather than hire, and Friday’s NFP report will show whether or not there is any hope on the employment front. Reduced numbers are likely to mean that the Fed will maintain current easy monetary policy. ISM Services figures round out the morning.

In the forex market:

Aussie (AUD): The Aussie is mostly lower after the Chinese rate hike and general risk aversion in the market after the Portuguese debt downgrade. Australia’s employment reports are due out tomorrow and dovish comments from the RBA the other day could further pressure the Aussie lower. (Click chart to enlarge)

Kiwi (NZD): The NZ GDP report that was supposed to be out has been postponed and at this point I don’t have any further information about when it will be forthcoming. So the Kiwi is lower on risk themes today.

Loonie (CAD): The Loonie is also lower as oil prices have pulled back and later this morning Canada will release its building permits figures which are expected to show a gain of 5% after last month’s dismal decline in excess of 20%.

Euro (EUR): The Euro is mostly lower after the Portuguese downgrade despite better than expected German factory orders and ahead of the ECB rate decision tomorrow. Should the ECB decide to not raise rates, then there could be a big sell-off. (Click chart to enlarge)

Pound (GBP): The Pound is also lower this morning ahead of tomorrow’s BOE rate decision despite higher home prices as the market is convinced that the BOE will be on hold for some time when it comes to rate hikes. As government austerity continues to add pressure to a declining economy, inflationary fears may be the only bullet left.

Swissie (CHF): The Swissie is mostly higher on risk aversion ahead of tomorrow’s CPI data and Friday’s employment report. Inflation is expected to have declined last month, which could mean that the SNB won’t have to act on rates anytime soon.

Dollar (USD): The Dollar is higher this morning on risk aversion despite the jobs cuts report which is expected to show an increase. The important figure to watch is Friday’s NFP, though the business appears to be unconvinced that the climate is getting better. The debt ceiling debate could help resolve some of these issues if a sensible compromise is reached.

Yen (JPY): The Yen is stronger across the board as carry trades are un-wound because of risk aversion.

The mandate at the ECB is not a dual mandate like it is here in the US. The sole mission of the ECB is to maintain price stability through interest rate policy. This means it needs to keep inflation in check. So they have to look at the strongest economies in the region with regard to how prices are affecting economic growth.

So even though many countries are going through painful austerity measures, it is probably a good thing that prices are not rising as the added costs would affect these countries more directly.

So why is it that the US government, particularly the Fed, so intent on causing inflation here through low interest rates? The answer is the housing market, the health of US banks, and our debt obligations abroad. If the Fed can sucker enough people into buying things now for fear that prices will be going much higher in the future, then they can essentially manufacture economic activity.

This unfortunately is not working, as the banks are not playing along and lending money as they fear further declines in prices due to reduced economic activity and potentially higher interest rates that our creditors may demand.

It is all too apparent that we are heading for what the Fed is trying to avoid, and as interest rates get raised in other regions around the globe, that’s where the money is going to flow. The history books and economic textbooks were written when the US was the only game in town. But that no longer is the case.

So put your money in places where it will work for you by investing in the forex market!

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Topics: What To Look At In The Market |

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