Outline of Currency Markets of the future

1900’s German economist Silvio Gesell’s economic theories were centered on negative interest would revive economic fortunes by rebuilding Inflation to meet mandates, higher GDP and for the ECB to force borrowings away from the central bank to private bank to bank markets. Europe Inflation at the time of negative interest adoption in September 2014 was practically 0 anyway and GDP at 0.3 so ECB methodology was to go negative and rebuild economically over time. So far 15 months into negative, GDP in September 2015 was 0.4 and Inflation for January 2016 was 0.2. The M1 money supply for the most part remained stasis while Draghi now claims Inflation will meet its 2% target by 2017 – 2018. To my current knowledge, Gesell’s experiments lacked formal adoption historically.
Negative interest for central banks means not headline but pure unadulterated manipulation of overnight rates. As Eonia went negative, Sweden, Switzerland, Denmark and Norway adopted or possibly was forced to adopt negative interest. Bulgaria remains 0, Israel is on the borderline at positive 0.10. Japan’s 0.1 negative is meaningless as positive 0.9 will apply in a three tiered system to a small portion to reserves. For Europe, Denmark, Sweden, Switzerland and Norway, all created small channels to control the overnight rate and applied to a greater portion of reserves. Our economic and market trading life is now found in minute channels.
The most conservative Swiss applies a 50 basis point channel while the ECB channel is closing by the quarter. When the ECB first went negative in September 2014, the Eonia / Refi corridor as the proper name was the fairly traditional 75 basis points. When Draghi last cut, the corridor was trimmed to 65 basis points. Should Draghi cut again and much room exists to do so then the corridor compresses to 55 basis points. Two cuts then the corridor becomes 45 basis points. My observation is two cuts is maximum for Draghi as more would mean a cut to the Refi rate. At 0.05, how much is left to cut. Overnight rates at negative is one aspect but a whole different crisis develops to see headline negative especially when other central banks align monetary policies to the ECB.

The Swiss and Norway set overnight rates above Eonia while Sweden and Denmark set rates below. Denmark was hit the hardest as the Krone is pegged but Denmark CD rates trade below Sweden, below Norway and above the Swiss. As EUR/USD wanders off course then the Danish central bank is forced to spend on intervention. The effect on the US and the US between Europe is inconsequential as 0.5 headline and 0.3 in Fed Funds merely joins the chorus in monetary convergences like we’ve never seen before. One nation falls or deflation hits then all nations follow because interest rates are on the floor and converging. If Yellen raises again, interest convergence remains. What convergence means for markets and currency markets in particular is massive slowdowns ahead. And who knows if further convergence aligns to an acceptable world standard in a Gold price.

In Draghi’s last speech, he mentioned to ” look at the exchange rate”. Possibly phase two yet nonetheless a shoking statement as ECB tradition was never mention exchange rates or acceptable levels. Past ECB head Jean Claude Trichet ( J C ) was careful in his tenor never to mention the Euro despite a barrage of questions over many years but central banks now own the corridors and are in a terrific position to own exchange rate levels and control volatility.

Brian Twomey


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