Before The Markets Re-Open, You Should Know About The Big Currency War Volley That Europe Fired On The 4th Of July

Due to the holiday, almost everyone in the US is blissfully ignoring anything market-related.

But actually there were fireworks today, and they emanated from the Bank of England and the European Central Bank.

In the words of Citi’s currency expert Steven Englander the “ECB, BoE make the world safe for currency wars.” And on the 4th of July, no less!

What happened?

Well it was the first meeting of new Bank of England chief Mark Carney (whom they poached from the Bank of Canada last year). Carney has been dubbed the George Clooney of Central Bankers, and he has the difficult task of reviving one of the most unimpressive economies in the world right now.

Carney’s move was to indicate that at a future meeting, the Bank of England might adopt forward guidance, i.e. stronger messages about how long the BoE would stay on hold.

Economist Justin Wolfers was amused.

As silly as that sounded, though, the market impact was significant.

The UK’s FTSE 100 stock market index rallied over 3%.

Meanwhile, the pound plunged.

Screen Shot 2013 07 04 at 5.24.43 PM

Why did the pound tank so much?

The aforementioned currency analyst Steven Englander explains (and note that the ECB did something similar, resulting in a similar Euro dive):

Both the ECB and MPC came out swinging today, promising forward guidance and low rates for as far as the eye can see. The problem is that interest rates in the US, euro zone and UK are heavily correlated. The effort that it will take to unwind the last two months’  upward move in UK and euro rates, assuming US rates stay flat, will probably put EUR and GBP under sustained pressure. In fact, UK and euro zone policymakers may be more successful in weakening their currencies than in restoring the May 1 profile of rates in their fixed income markets.     

A glance at Figure 1 shows that the upward moves in euro zone and US interest rates caused by the backing up of US yields is large relative to interest rate differentials that normally persist between these bond markets. This makes us think that it will take a strong policy to unwind the rates move, and that policymakers are likely to encourage GBP and EUR because this pushes financial conditions in the desired direction.

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So today was a very active day for a holiday.

And tomorrow should be as well, as we get a US Non-Farm Payrolls report that’s significant, in its own right, as a measure of the economy’s health, as well as for what the US Federal Reserve will do next.

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