Divyang Shah, Senior IFR Strategist
(*Correction appended)
The steepening of money market curves in both UK and eurozone has reversed slightly, while, in FX, both the GBP and EUR weakened sharply against the USD. The combination of flatter curves and weaker currency has reversed the tightening in monetary conditions over the course of the last few weeks.
The question is whether forward guidance will be sufficient to prevent UK and eurozone assets from being swept along with the tide as the Fed likely tapers QE as early as this September.
The Fed can lend a helping hand by improving its own communication as it has failed to convince financial markets that:
1) an eventual end to QE does not mean that rate hikes are around the corner, and
2) that tapering is about not wanting to add to existing accommodative policy and they have no intention of removing accommodative policy.
Forward guidance from the BoE and ECB will allow money markets to be divorced, even if bond markets continue to stay correlated.
The most interesting aspect of the market is that money markets are listening, despite the fact that the BoE and ECB (*) have delivered softer versions of forward guidance.
Contrast this with the Fed, where they have a hard version of forward guidance that is based on numerical thresholds, yet they are still finding it difficult to convince financial markets.
(*Corrects from earlier version which had “the BoE and Fed”)
