Wednesday, Oct 07, 2009
Apologies to Sarah - its a chart- but relevant to the conversation yesterday
EWI: Illusion of Control: Central Banks and Interest Rates
But it illustrates what i was saying about rates and markets.IF the markets wanted it the UK would be forced to raise rates.
Posted by techieman @ 09:59 AM (1711 views) Add Comment
41 Comments
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1. mark wadsworth said...
Yup. VMR at this very 'blog pointed out that historically, BoE base rate always followed three month sterling LIBOR, which turns out to have been true until late 2008*, since when there has been a total disconnect between market interest rates and the BoE rate.
* The easily availabe data only goes back to 1978, but there's no reason to assume that things were different before then.
2. mark wadsworth said...
Oops. Tag not closed properly.
3. jonb said...
They've confused cause and effect. The three month t-bill market tries to predict what will happen to base rates over the next three months. It usually gets this right, but not always.
4. luckyjim said...
jonb
spot on
5. mark wadsworth said...
@ JB, LJ, yes, of course there is an element of that. But we have enough "history" to look at. Over the past year or so, BoE rate has been ridiculously low, and the government has more or less promised a year ago that the totally independent BoE MPC will keep it low for the foreseeable (to keep the house price bubble going) and there is now a disconnect between 3M LIBOR and base rate. Or why did it take over a year for 3M LIBOR to fall to 0.62%?
Figures from BoE website:
30 Nov 08 4.4
31 Dec 08 3.21
31 Jan 09 2.28
28 Feb 09 2.08
31 Mar 09 1.83
30 Apr 09 1.48
31 May 09 1.3
30 Jun 09 1.21
31 Jul 09 1.03
31 Aug 09 0.8
30 Sep 09 0.62
OK, there's still an 0.12% spread (or 12 bips, to use the trade parlance) or "risk premium", but that in turn is a measure of how confident banks are that other banks will be bailed out.
6. techieman said...
Well i hate to disagree with you chaps - jon and LJ - but when i was in the short sterling pits it was very rare (yes it did happen) that the move wasnt discounted. So what would normally happen was the short sterling would move and then the rate would catch up. Of course this is not in the lack of confidence time. So yes at the end of the day the short sterling contract must synchronise and sometimes the discount or premium doesnt result in a rate change but to say that alot of times the market doesnt push the bank - is in my view and experience not quite right.
Sometimes its true the authorities caught the pit off guard but that was very rare. I know cause the times it happened i was either on the right side or square going into the announcement.
7. Snake Oil said...
Its not quite that simple. Banks also manipulate LIBOR via manipulating reserve ratio's and providing overbank lending. But ultimately, you are correct.
8. luckyjim said...
MW
I agree there has been a disconnect as risk has become the dominant factor. I'm not even sure why we're discussing it.
9. jonb said...
LIBOR increased because the risk premium increased. To see what the risk premium is, look at the spread between 3 month LIBOR and 3 month GILT yields. That used to be about 0.1%. It increased to over 1% at one point, and now it is back to 0.12% as confidence in the banks has improved.
The other issue at that time was simple supply and demand. The banks were looking to borrow trillions and the bank of england only had hundreds of millions to play with.
10. flashman said...
It is only in times of turmoil that the two do not move in lockstep (with base following T-bill (as per techie’s experience) but you cannot have a discussion about the relationship between T-bills and base rates without talking about the spread between LIBOR and base rates and LIBOR and various other yields (as jonb says). They are all related. These spreads have long periods of stability and tight correlations in between economic traumas (after 1994 up until the crisis in 2007). In other words, there is a tight relationship between LIBOR, 3 month T-BILLS and base rates until something goes wrong.
On the other hand, the spreads between LIBOR and base have generally been marginally increasing since the early 70's which suggests a very gradual loosening of the lockstep relationship but the relationship is still very much there.
In any case I don’t think we can use 3 month T-Bills to predict base rates because we cannot reliably predict 3 Month T-bills.
HPC'ers hope for higher interest rates but we have very little help with predicting them other than a hyper short term, lockstep relationship
Love Saucy
11. techieman said...
We are discussing it because most people think the gov determines rates based on its view, whereas in fact it succumbs to the market wants. That is important because the next leg may be caused by the markets losing faith in the ability of the gov to pay back what it owes. They (the government) will then have to respond to the market. The market has historically caused a run on the pound and the government must react to that (eg raising rates) not lead it.
12. flashman said...
"whereas in fact it succumbs to the market wants"
Unarguably true
13. techieman said...
Flash " we cannot reliably predict 3 Month T-bills." unless we use TA of course
Joking!!
Have a good one Ketchup!
14. flashman said...
hey techie; just to clear up the real flashmans view on TA
I think that in the hands of an experienced and talented trader it is an invaluable and profitable tool. In the hands of a beginner it is a recipe for disaster.
Charts and indicators are indispensable because they give us a picture of the market far quicker than we could deduce by ‘eyeballing’ alone. In fact all charts are useful for this reason (not just market charts)
57 varieties
15. mountain goat said...
Glad this discussion is happening because I think it is important and relevant, even more so because larger volumes of gov bonds are hitting the market. Unfortunately I can't add anything sensible because bonds prices leave me deeply confused...
16. luckyjim said...
jonb has explained why that isn't the case.
Yes the government reacts to things. If inflation rises above their target they (or their bank) will raise base rates. If they were bothered about the exchange rate they might react to that too. But that doesn't mean that the market is setting the base rate. The article puts forward a very weak case.
I should clarify - I don't know why I'm discussing it.
17. techieman said...
"Charts and indicators are indispensable because they give us a picture of the market far quicker than we could deduce by ‘eyeballing’ alone. In fact all charts are useful for this reason (not just market charts)" - Exactly - in THAT thread yesterday i explained what i thought charts (of financial instruments for example) - actually are. i.e. a track of the thoughts of people and their reactions to the news or the lack of it.
Whether you believe in TA or not - i.e. that you can predict movements based on the prior price history as detailed in a chart, they are what they are, so as you say you can just use them to show where we've been -and where we currently are. I agree that to use them for where we are going is much more controversial and i can take on the chin - hocus pocus / jiggery pokery / whatever arguments on the chin much more easily than a 200 pip spike loss in the currency complex!!
Perhaps i was burnt at the stake in a prior life - but then i suppose i would have to have been female then..
18. flashman said...
mg: the bond market is the 1000lbs gorilla. Nothing can stand in its way. I have always believed that tier 1 bonds are a good indicator for what will happen in the medium term. The banks are currently issuing at rates between 8.5% and 10%.
The banks need to raise the money and they are having to pay a large coupon. One way or another their customers will pay for this
luckyjim: What you say is true but the BOE is still constrained by market rates. It can not stray too far from the higher and lower bands that are dictated by the market. If they did stray too far, their rate would not be effective
19. techieman said...
LJ - you are right its not the best article ever written on the subject - its actually a marketing ploy, but it is aimed at our transatlantic friends. I have actually said enough on the subject you believe whatever you believe. It would be good to find a definitive article - agreed.
Are you not discussing it because you believe there is nothing to discuss - i.e. you are right, or because you believe its not an important issue?
MG - re the Gilt contracts (i assume you mean they are going up when they "should" be going down?). Yes to be honest i havent traded Gilts for a long long time - it used to be a really great market but i have lost interest in them really the T-Bonds, the Bund and even the BOBL all used to be favourites of mine. Aw well.... life goes on.
20. luckyjim said...
flash
Yes, I agree, like when they cut rates to 0.5. It had little or no effect. But if you believed the market set the base rate the BoE would have been forced to raise rates. They didn't. They just left them at 0.5 and sought over means to coerce the market into following their lead.
21. mountain goat said...
TM - "MG - re the Gilt contracts (i assume you mean they are going up when they "should" be going down?)."
not really, I just meant I am aware that government spending since the bailouts has reached new realms of the ridiculous lately and this must be paid for in the short term with increased issuance of gov bonds, since tax revenues are falling because of the recession and so bailouts can't be funded immediately. So because of this I am wondering how this affects demand for bonds, bond prices and therefore IR. So if in reality the tail wags the Central Banks dog with respect to setting of IR where does this all lead?
22. mystie010 said...
"Almost no one expected a major central bank to raise rates amidst the ongoing financial crisis. That's why the RBA's decision "was largely interpreted as a sign that the Australian central bank is confident in an economic recovery." (RTT news)
And no-one is expecting UK rates to rise in Feb next year either - except me that is :-)
Watch this space...
23. cynicalsoothsayer said...
@flash Looks like bond yields has been ratcheting up since the early summer. Is this a sign of something about to happen?
24. flashman said...
cynicalsoothsayer: Yes it probably is. Only a double dip recession can stop rates rising because investors will flock to bonds for safety.
Governments, business and banks alike need to raise large amounts of cash. Going forward, if we achieve tepid growth levels or even stagnate, then interest rates will rise because the sellers of bonds will be forced to increase their coupons to attract business. Its supply and demand 101
25. cynicalsoothsayer said...
So are official interest rates going to follow the market (bond) rate to reach between 8% and 10% then?
26. flashman said...
cynical: The 8% to 10% rates I quoted are for tier 1 bonds. There is a wide range of 'market' rates at any one time and tier 1 bonds tend to be at the far end of the spectrum
However, the official rate could easily reach 8% and beyond because it has exceeded that many times in history for lesser reasons. Once interest rates rise, it is quite normal for them to continue to rise for a few years at a time. I would expect them to start rising at the back end of next year. I have no idea where they will end up but I would not be at all surprised to eventually see mortgage rates of 15% plus
27. flashman said...
Here's a link for anyone who wants to see the official Bank Rate history since 1975. It makes you realise how unsurprising it would be for the official rate to end up above 10%
thhttp://www.bankofengland.co.uk/mfsd/iadb/Repo.asp
28. flashman said...
sorry: http://www.bankofengland.co.uk/mfsd/iadb/Repo.asp
29. jack c said...
@flash - thanks for the input and the links - Interestingly I found this in todays fundstrategy online publication
Roger Bootle, the managing director of Capital Economics, forecasts that interest rates in Britain will remain at their current level for the next five years.
Speaking in the first session of the Fund Strategy Investment Summit in Dublin, Bootle said while the market expects rates to rise soon—exceeding 3% by the end of 2011—he anticipates no change in American, eurozone or Japanese rates in the next two years at least. However, in Britain he is confident rates will remain at 1% for the length of any new parliament.
While Bootle said a global depression has “probably” been avoided, he added the global recovery faces a long period of low growth.
Full article @ www.fundstrategy.co.uk/cgi-bin/item.cgi?id=194736&d=560&h=527&f=518
30. flashman said...
Hi jack: Bootle used to be my favourite economist. He went against the herd for years and insisted there would be a house price crash. Then about 9 months before it happened he lost his bottle and changed his mind. He did this because Capital Economics was losing credibility and clients. He is a very smart cookie but he is a bit of a rock star economist these days and I suspect he has decided to join the uber bear cool club. He recently got another bloody nose when the stock markets started rising so he must be quite frustrated now.
Of course he might well be right but most economists disagree and his recent track record is quite poor. I'm not wedded to my opinion so it will be very interesting to see how things unfold.
If we get a mild recovery that lasts for 3 consecutive quarters money will come out of the bond markets and interest rates will rise. That's my bet but I'm no more than 60% confident
31. jack c said...
Hi flash - agreed Roger B was definitely one to take notice of but he has become a bit more celebrity these days. I cant personally see how rates will be held down that low for that long and it will therefore be interesting to see how things develop in the next 6-12 months.
32. mr g said...
So, after all the jargon, in plain English, what are we saying?
33. Sara said...
I've been having a discussion with the girls in the office (we're all avid readers of the site but we're a bit thick so don't like making comments) and I'd just like to say how much we all fancy you flash. Anyway, I've said my bit now so won't be coming back. Ta ta.
34. cynicalsoothsayer said...
@mr g: Interest rates up soon. More financial turmoil coming.
In that article Bootle is as vague and random as a tabloid astrologist. Oh wait, that's what Capital Economics kind of are.
35. cynicalsoothsayer said...
@mr g: Interest rates up soon. More financial turmoil coming.
In that article Bootle is as vague and random as a tabloid astrologist. Oh wait, that's what Capital Economics kind of are.
36. techieman said...
more plaudits for the flash. I think i need to reinstate the saucy sarah tag because if that isnt what is? And to think i felt bad about it yesterday - women you cant live with em and ..... you cant live with em!
37. cynicalsoothsayer said...
@Sara: Flash is a bit of a God on here. I avoided losing of a lot of dosh by getting out of bank shares at the their peak due to him warning about the banks being bust from US hpc before they officially went bust, so I'm a fan too, but I don't think I fancy him ;-)
38. This comment has been removed as it was found to be in breach of our Blog Policies.
39. techieman said...
Hey Krustie - what makes you think that i dont find hirsute women a turn on? As for Flash being a saviour - well of course he is and also king of the impossible, and will save every one of us :-).
http://www.youtube.com/watch?v=wNf9rEPoc8Q
"[Flash] Gordon is ALIVE?"
40. flashman said...
Cool!
Don't worry about these interblogical disturbances. I WILL save everyone of you
FLASH!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!
41. cynicalsoothsayer said...
OK maybe it wasn't Flash, but the discussion way back then about the investment banks et al being effectively bust saved me a lot of loss. The impartial and insightful intelligence shown by some of the contributors to this site can be very useful, while many readers will be put off by the more loony element here.
I might have been posting for a short while, but I've been reading it for years. Still trying to find that discussion in the archives...