Have Global Interest Rates Peaked?

With the ECB adamant that it will continue to raise rates this would seem to be the most untimely of questions, but there are now signs that this may well be the case.

Firstly this in Bloomberg today:

Federal Reserve to Cut Rates in 2007, Corporate Bond Sales Show

Thinking about refinancing your mortgage in the U.S.? Wait a year. Considering a certificate of deposit? Sign up now. While economists debate whether the Federal Reserve will cut its target interest rate for overnight loans between banks from 5.25 percent, investors have already decided the central bank will reduce borrowing costs next year. Nowhere is that clearer than in the market for floating-rate notes, whose interest payments rise and fall with central bank policy. Sales of so-called floaters are slowing for the first time since the Fed started raising interest rates in June 2004. They’ve fallen to $21.5 billion in September from a monthly average of $35 billion this year through August, according to data compiled by JPMorgan Chase & Co.

Now one swallow doesn’t make a summer, and it is early days yet, but take a look at ten year US Treasury Bonds:

U.S. 10-year Treasuries fell, halting a five-day rally, before a report today forecast to show consumer confidence gained this month.The gains ended on speculation yields at their lowest since March will deter some investors. The yield on the benchmark 10-year note rose 2 basis points, or 0.02 percentage point, to 4.56 percent as of 6:37 a.m. in New York, according to bond broker Cantor Fitzgerald LP. The price of the 4 7/8 security due August 2016 fell 5/32, or $1.56 per $1,000 face amount, to 102 15/32. Bond yields move inversely to prices.

So today we have nudged the yield back up a little, but the rate has been dropping steadily since March. And yesterday Bloomberg were being even more explicit:
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Schyzophrenia Outbreak At The FT?

I know you should never take what a central banker says at face value, but still. Today Christopher Swann in Washington tells us (in an article entitled: End in sight to the Fed’s rate-tightening cycle – and with no question mark):

For much of the past year and a half the Fed has been running almost on autopilot, with rates being raised from their historic low of 1 per cent in June last year to 4 per cent now in a lockstep of quarter-point moves. None of the economic vicissitudes over the past 18 months – from Hurricane Katrina to surging energy prices – has diverted the Fed from its gradual task of bringing rates to a more neutral level.

But this week’s minutes suggested in the clearest language yet that this task is almost done. In 2006 any further rate rises will have to be justified by surprising economic data, the Fed’s internal discussion appeared to indicate.

For the first time since the rate-tightening began, some of the members of policy-making committee also warned about the dangers of going too far

Meanwhile, back home in the UK, Steve Johnson has this:

“In contrast to the ECB’s caution, comments from the US Federal Reserve hinted at several more rate hikes to come.

Michael Moskow, president of the Chicago Fed, suggested that the Fed funds rate would rise above the “neutral” level expected by the market. “With inflation at the upper end of my comfort zone, an unexpected increase in inflation would be a serious concern.””

So come on lads, get your act together, which is it, almost done, or plenty of juice left in the lemon yet awhile?

More On Exchange Rates and Policy Rate Differentials

Morgan Stanley’s Stephen Len is obviously on the same page as I am about how the rising interest rate differential between Europe and the US is likely to drive short term currency movements:

Policy rate differentials are especially important now for the currency markets, and it pays to focus on central banks these days.

Reason 1. Global monetary paths are diverging, not converging. Among the major economies, only the US has an output gap small enough to support tightening. I doubt either the ECB or BOE will be in a position to tighten rates this year. Many now understand quantitative easing must be terminated by early next year, but no one has proposed actually raising interest rates from zero. Therefore, monetary paths are diverging, with the rest of the world having trouble keeping up with the Fed. This makes the Fed much more important for the USD than in ‘normal’ times.

Reason 2. Global equity portfolios are likely to be out of balance. Since 2003, there have been massive equity flows into Euroland and Japan. Since much of these flows occurred when the USD was still in structural decline, and some of the outflows reflected fears of a USD crash, it makes sense to suspect hedge ratios are quite low on these equity outflows. With the rise in the FFR and resilient dollar, the cost of running these currency exposures is increasingly unjustifiable. The equity market cap-weighted short-term interest rate differential between the US and the major markets is now around 180 bp, and still rising. If the Fed takes the FFR to 5.0% by end-2006, the differential will reach levels last seen in 2000.

ECB Interest Rate Policy

Brad Setser has a post today on Kate Moss, not provoked by her evidently economically intriguing modelling properties, but due to the Kate-Moss-thin credit-spreads which Bloomberg’s William Pesek refers to in this article. What really turns Pesek on it turns out isn’t Kate Moss at all but the possible existence of links between China’s economic boom and the recent surge in popularity for credit derivatives.

And it is in the context of this evolutionary chain that Brad Setser’s work on China and Systematic Risk offers itself as some kind of missing link.
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Close Call

The reference here isn’t to the actual hurricane (which was far from that if you were black, poor, and lived in downtown New Orleans) but to the economic ‘near miss’ I think we are watching, and to the difficult decision Alan Greenspan and his team will now have to take on 20 September next.

The blogs are of course rife with speculation.

Update: Dave at MacroBlog just came up with one more reason the Fed might steadfastly remain on course: poor productivity readings.
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Too Hot to Change?

The Cunning Realist takes a look at limits:

Since the bursting of the technology bubble in 2000, there have been four distinct periods in which the Fed has flooded the system with an extraordinary amount of liquidity in an effort to boost the stock market:

1. Immediately after 9/11.
2. During the second half of 2002 in response to widespread accounting scandals and the meltdown in the corporate bond market.
3. During the summer and fall of last year, just before the presidential election (draw your own conclusions).
4. The past two months.

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Things That Can’t Go On Forever, Don’t

Ok, the sun is shining nicely down here in Barcelona right now, so maybe this is a good moment to come out and provoke a storm. The euro: something gives, but what? Actually it is perhaps ironic that I have chosen today of all days to write this, since for once it seems the euro may fall rather than rise: well to someone who is accustomed to marching out of step, this almost seems par for the course. Never mind, tomorrow, or the day after, we will be back to normal, and the seemingly unstoppable rise will continue. The only remaining question really is: where is breaking point, and what will happen when we get there?
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