China, the ECB and Janet Yellin – or Macro Markets 101

• Posted by Greg Harmon
• on October 28th, 2015

Last week the ECB held rates and their asset purchase program steady. The next day the Peoples Bank of China (PBOC) cut interest rates there. And markets seemed to be surprised. I wrote briefly on twitter that these actions were necessary because the Fed did not tighten interest rates in September. Here is why.

The Fed, ECB and PBOC have a symbiotic relationship. You can add in the Bank of England and the Bank of Japan. With a free floating currency market the actions of one Nation on monetary policy effect all the other Nations. We are all global citizens.

Take this one step further beyond the actions and you get to the expected actions. When the Fed is expected to raise rates, that is a bias toward higher rates in the US. Capital flow is then biased towards the US, all other things being equal. From other Nations perspectives, this bias is interpreted as a bias toward easier money locally. So if a nation (like China or a block like the European Union) is considering easing monetary policy but a large nation (like the US) is biased to change higher, they can delay or maybe even forgo their move to easier money.

But when that bias in the US is erased or delayed, it also impacts China and the European Union. So when the Fed did not raise rates in September it shifted the bias to a strong one to delay tightening or increase easy money ion China and the European Union. It should not have surprised anyone that Draghi softened his stance on tightening and China cut rates.

Fast forward to today. The FOMC ends it meeting this afternoon and will release a monetary policy statement. The Fed Funds Futures market gives it a 4% chance of including a monetary tightening. This will likely not impact global flows much for many reasons. One is that they FOMC has stated they would like to tighten the first time at a meeting with a press conference. There is none today. Second the dual mandate on employment and inflation is still showing inflation lagging the long run target. There is no need to tighten.

You will read a lot about how the FOMC wants rates to return to normal. And they likely do. But they also have a real important job to do balancing employment and inflation. There mission is not to return to normal but to maintain this balance, and it is out of whack. So stop listening to what pundits think the Fed, ECB of PBOC should do. They are all talking their book. Watch the data, and see how the dance plays out. This will give you a much better backdrop for your trading and investing ideas.

Now back to the charts.

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