Forward Misguidance From Central Banks Is A Volatility Gift

By Simon Flint, Bloomberg Markets Live commentator and former head of FX research at Merrill and Nomura

The Bank of England meeting was not just a game changer for sterling assets.

Coupled with the RBA’s decision, it weakened faith in central bank communications, demonstrated different reaction-functions to market pressure, elevates the importance of data, and could lead to higher volatility. The U.S. dollar may be selectively well-positioned to benefit.

The past week has taught us:

• Central bank communications can be unreliable. This is especially important at this policy turning point. Even now the dust has settled on the RBA, it’s still amazing to think that prior to its meeting, RBA had a stated yield target of 0.1% and yet they allowed yields to approach 0.8%. Bank of England’s communications lapse was less egregious, but a hike on Thursday seemed well flagged

• Central banks react differently to market pressure. To an extent, RBA’s policy change was forced by yield moves. Governor Lowe said “The board took into account that the shift in the distribution of possible outcomes was already being reflected in other term interest rates in Australia,” On the other hand, the BOE may have felt that short-end market pricing, and its impact on GBP had already done its job. Catherine Mann, an external member of the board previously heralded this by saying “There’s a lot of endogenous tightening of financial conditions already in train in the UK. That means that I can wait on active tightening through a Bank Rate rise.”
  

• Data is increasingly important, in the absence of reliable guidance

• Vol can make a comeback. Uncertainty about central bank communications, and differences in policy reaction functions could allow volatility to make a sustained come back

• USD is selectively well positioned. A casual observer opening their Bloomberg screen in Asia could be shocked by the strange confluence of much lower USD rates, a rallying stock market and a higher dollar. Obviously this is because a number of other markets have more space for short-term rates to fall. Although a chunk has been priced out this week in (especially) U.K., Australia, Canada and New Zealand. There is still a decent premium (especially in the latter 3), as per pricing in MIPR

• In with the old. Britain, just as it did with Brexit, reminded the world that – for good or for ill – it remains a global force in markets. And, old STIR/bond traders will be dusting off their resumes now that rates trading is back — as MLIV’s veteran squawker Tommi Utoslahti pointed out