Global Markets, ECB, China Over Night Rates and GBP


Despite noises coming out of the Fed – provided by the hawkish Esther George and non-voter Jeffrey Lacker – suggesting that September is a ‘live’ meeting, the risk outlook remains supported for now. The Fed’s September Beige Book showed rising wages but muted inflation pressure, supporting our view that, within a globalized economy, costs are local, impacting local profit margins while inflation is global, held back by global overcapacity.
China saw its exports (-2.8%Y after -4.4%Y) and imports (1.5%Y after -12.5%Y) rebounding in August and its car sales surging by 24%Y in the same month. China’s coal imports reached their highest level since 2014, which may be interpreted as China having made some progress in reducing inefficiencies and loss-making over capacities. Meanwhile, the cost of borrowing yuan in Hong Kong surged to a seven-month high amid speculation that the PBOC is intervening to discourage bearish bets on the currency. The overnight HIBOR climbed by 388bp to 5.45%, reaching its highest level. This indicates that the authorities may not want RMB to increase the pace of depreciation at this point. August reserves, current account and commercial banks’ FX purchases suggest that China’s capital outflows have reached about US$50bn – the highest level since February. For now, the HIBOR rise is a reassuring measure as it calms speculation that RMB may fall at a faster pace. However, should rates jump further from here, then calm may reverse into fears that higher rates may hamper domestic funding flows.

Today, the ECB will lay out fresh growth and inflation projections. July’s ECB interest rate statement and the press briefing left the impression that the ECB has entered a reflection period, evaluating whether it’s past monetary tool settings moved it closer to reaching its inflation and implicit growth targets. Similar to the BoJ, the ECB relies on three tools, namely negative rates and QE to dampen bond yields and private sector asset purchases to enhance corporate credit. The result of this policy has been mixed at best. On the positive side, it helped sovereign and corporate spreads to ease, but the flattened yield curve has not done any good to banks’ balance sheets. The yield curve provides an indication for bank profit margins. Tight profit margins and declining share prices reduce the risk-absorbing capacity of banks. Consequently, banks focus their businesses on low-risk areas, which has significant implications for asset allocation within an economy. Distributing assets into safe but low-yielding investments reduces productivity and profitability, keeping wage growth muted. A better monetary policy should aim to break this vicious circle. A new thinking may recognize that flat yield curves may do more harm than good.

The concoction of GBP-negative factors yesterday is an appropriate reminder of the key short-term risks to the currency: dovish BoE talk, weaker UK activity data and an increase in Brexit-related noise led to a retreat in bullish GBP sentiment. We suspect these factors will continue to place a lid on any material GBP upside going forward, with 1.3400/50 now a key resistance area for GBP/USD. Although Governor Carney admitted that the post-Brexit UK data has been a “bit stronger” than expected, there was sufficient evidence in yesterday’s testimony to suggest that a risk-averse MPC will likely exercise its option of another Bank rate cut. We still see the balance of risks skewed towards a 15bp cut in Nov and with markets only pricing in a 38% likelihood of this occurring, we prefer to stay sellers of GBP going into next week’s BoE event (15 Sep). There’s a good chance that the MPC re-iterates its view to act further and this will nudge UK rates (and GBP) lower.