The views expressed in this column are solely those of
the author and do not reflect the views of SVB Financial Group, or Silicon
Valley Bank, or any of its affiliates.
In the last few months, we
have had governments overthrown, devastating earthquakes, the U.S. has entered
its third armed conflict, and some countries are on the verge of bankruptcy. In
addition, the U.S. economy is struggling along and has yet to produce enough
jobs to the unemployed. All these factors, and more, have added little
tranquility to the financial markets, resulting in several confusing and very
volatile months. The USD fell before it strengthened, only to fall again. The
latest fall in the USD seems to be more about rising inflation and economic
fundamentals and less about the chaotic geopolitical events and natural
disasters.
The Sterling
The trend for the sterling has been positive as many have become increasingly
convinced the Bank of England (BOE) must raise rates to control inflation. The
Great British Pound (GBP) has climbed to 18-month highs, trading above $1.64
last week, well above the $1.60 rate many had forecasted would be the top. And
it appears the sterling could continue to benefit as the market believes the
BOE will be forced to hike rates to fight escalating inflation pressures. Last
week, after stronger-than-expected economic data and comments from the BOE,
policymakers concluded that inflation will remain high this year. Bank of
England Chief Economist Spencer Dale said they expect global rates to increase
faster than they forecast late last year. Consumer inflation in Britain jumped
to 4.4 percent, double the BOE's 2.0 percent target, prompting BOE Governor
King to acknowledge that interest rates might rise more rapidly than economists
had expected. This was before events in Japan and rising turmoil in the Middle
East pushed up energy prices, potentially adding more pressure to inflation. In
addition, Rightmove Plc said British home prices have risen for the third
consecutive month.
The British central bank will probably not hike interest rates until the third
or fourth quarter of this year. The three-month GBP LIBOR rates are now at .82
percent, while the 1-year is at 1.6 percent, up from 1.46 percent last month.
However, there is a growing proportion of the market expecting rates to mover
earlier. BOE members have indicated that monetary policy tightening is likely
to begin with rate hikes rather than by selling the GBP200 billion assets
purchased under the quantitative easing (QE) program between March 2009 and
February 2010. The yield on the 10-year gilt is rising as more data shows that
U.K. inflation has accelerated to the fastest pace in more than two years,
which may add to pressure on the Bank of England to raise interest rates
faster.
The EUR
Not to be outdone, the European Central Bank (ECB) is also hawkish on
inflation, and effectively pre-announced a rate hike at their last meeting in
April. The rate is likely to be lifted by 25 basis points to 1.25 percent to
help contain the inflation risk. ECB President Trichet recently stated,
"Economic data confirm that the underlying momentum of economic activity
in the euro area remains positive...It is essential that the recent rise in
inflation does not give rise to broad-based inflationary pressures over the
medium term...Strong vigilance is warranted with view to containing upside
risks to price stability...Rising commodity prices are putting pressure on
inflation that is quite clear, it is a reason to monitor even more closely than
before the inflation developments in Europe." These remarks indicate a
clear shift in the ECB's conclusions compared to previous statements, when
Trichet said that rates still remain appropriate. However, the ECB also
stressed that uncertainty remains concerning the "current very
accommodative stance of monetary policy lends considerable support to economic
activity." The EUR has risen from 1.29 to its current levels near 1.42
since January, 2011.
Conclusion
Meanwhile, the U.S. Federal Reserve is seen taking a more pro-growth approach.
The recent economic data seems to outweigh any inflation concerns. Last week
U.S. new home sales declined almost 17 percent to the slowest pace since
records were kept. Home prices dropped to the lowest level in eight years.
February industrial production was down .6 percent, lower than what many
forecasted. In addition, consumer confidence and consumer spending is not what
we would hope. The result is the FOMC has left interest rates unchanged and
reiterated the "extended period" language. However, they have
slightly upgraded the economic and employment outlook while stating core
inflation is "subdued" and recent commodity surges are likely
"transitory."
The wild card in this situation is how the market reacts to the most recent
political/economic crisis in some of the EU nations and any effects from the
earthquake in Japan. Portugal needs to do everything possible to make sure it
can issue debt, and will need to show that it can meet its objectives. Ireland
also remains under pressure as the government has not yet managed to
re-negotiate the conditions of the bailout terms. There is also speculation
that Spain, which accounts for 10 percent of the European Union GDP, may also
require a bailout. The Japanese government estimates that the earthquake damage
may cost over $3 billion due to damage to roads, homes, factories and other
infrastructure, but excludes lost economic activity from power outages and
costs arising from damage to the nuclear power plant, as well as the impact of
market losses and business. For now, right or wrong, the market is trading on
the interest rate outlook. Good luck.
Foreign exchange transactions can be highly risky, and
losses may occur in short periods of time if there is an adverse movement of
exchange rates. Exchange rates can be highly volatile and are impacted by
numerous economic, political and social factors, as well as supply and demand
and governmental intervention, control and adjustments. Investments in financial
instruments carry significant risk, including the possible loss of the principal
amount invested. Before entering any foreign exchange transaction, you should
obtain advice from your own tax, financial, legal and other advisors, and only
make investment decisions on the basis of your own objectives, experience and
resources.