Sonia: Reforms, Levels, Ranges, Targets

80% of UK’s trading in benchmark overnight interest rate termed Sonia occurs in London, 12% in Brussels and 98% derived from all Europe. Aggregate volume totals last month were 8 to 10 billion GBP and consistent against 10 billion monthly trade in European overnight Eonia. Since July 2015, proposed reforms to enhance Sonia trading by banks and Building Societies are in advanced consultative stages alongside expected completion by Q2 2017. Banks, traders, Building Societies are currently testing operational changes, risks and new system development.

The UK’s system in design and trade in interest rates is one of the most robust and stable systems ever designed. Nations formerly pegged to GBP over the past 200 years such as Australia, New Zealand and Canada all designed their own system of interest rates based on the UK although with slight variations. The robustness of the UK design allowed London now and far from the past to become the home of finance in bond offerings and exchange rates. Therefore the only major changes to occur in Sonia is a time change but its the most profound and consistent with other central banks in redesign of interest rates by looking inward rather than outside its own borders.

Traditional release of Sonia occurred at 5:30 am NY time and consistent with the London Gold Fix. The new 4:00 am NY proposed time change will transpire between 3:30 and 4:30 am NY against GBP news releases and after the 2:30 am Mumbai currency Fix. As the Europeans plan to limit volatility by its interest rate redesign, the UK proposes enhanced volatility in GBP and all UK markets by Sonia time changes. The question will GBP volatility roll over into American markets is yet not known.

Based on Sonia current redesign efforts, Carney’s proposed interest rate drop comments maybe on hold until after Q2 2017 unless the UK deterioriates or tradgedy strikes. Add the fact of June’s low occurred Friday in Sonia at 0.4589 and places a floor on GBP/USD at 1.3100 to 1.3200.

Knut Wicksell’s equilibrium, natural, neutral interest rate for the UK based on Sonia monthly averages from 1 to 20 years is found at 1.888 and derived from the 20 year average high at 3.3368 to 0.4408 lows. The level at 1.888 is located just above the 10 year average at 1.6501 yet just below the 12 year average at 2.1141.

Traditional Wicksellian equilibrium is defined in economic terms as the location of the interest rate viewed from 20 to 50 year averages. The purpose is to define price stability and monetary policy in terms of to tight or to loose in money supplies. A current interest rate above the natural rate restricts economic activity and leads to lower prices while an interest rate below the natural rate leads to higher prices and enhanced economic activity.

With increased QE and higher money supplies particularly M1, the natural rate was redefined operationally post 2008 to the point where interest rate borrowers profit, supply equals demand, economy performs and the money supply is at a correct level. Obviously QE failed the equation as money is to loose and must restrict in order for economies to revive after an 8 year hiatus.

Taken from the ECB example and an example that holds true for every nation, Eonia and M1 negatively correlate at 85%. The BOE adopted QE and rising M1 while Sonia was 5.000 before the crisis and steadily declined to current historic lows not seen since Sonia was introduced in 1997.

Overall ranges for Sonia are found from 0.4918, 0.4987 highs to 0.4204 lows although many points exist in between. The next point breaks below are 0.4574, 0.4567, 0.4561 then 0.4504. Below 0.4505 comes next 0.4498, 0.4416, 0.4408, 0.4329 and 0.4322. Below 0.4322 point breaks comes next range breaks at 0.4266, 0.4257, 0.4245, 0.4231 and 0.4204. Most important breaks are 0.4416 and 0.4408.

Above points from the 0.4589 close, 0.4605, 0.4611, 0.4622, 0.4627 and 0.4645. The most significant break is 0.4645. Range points come next at 0.4649 and 0.4653.

Current 0.4589 is located at targets 0.4587, 0.4585 and 0.4569. The upper target at the 5 year average aligns as 0.4918 and happens to be most oversold in GBP/USD among the longr term averages. Then targets begin a descent to 0.4300’s and 0.4200’s.
In order for Sonia to travel higher or for Carney to ever raise then the 8 year average at 0.7414 must break higher. Then comes the 9 year average at 1.2758. The 8 year average is the major delineation line among all averages from 1 to 20 years. Currently Sonia trades between the 6 and 4 year monthly averages from 0.4645 to 0.4408 and an average of 0.4526. Overall what drives Sonia rates are averages from 1 to 8 years. The 3 and 4 year averages at 0.4416 and 0.4408 restrict any Sonia rises as they become overbought yet Sonia contains hurdles at the 1, 6 and 7 year averages at 0.4611, 0.4645 and 0.4622. Crossovers in the 6 and 7 year averages occurred as both crossed above averages from 1 to 5 years.

Sonia is an acronym for Sterling Overnight Index Average and its an average between the difference of secured V unsecured transactions in UK interest rates to include Repo rates, OIS rates and other interest rates. Sonia, unlike other nations interest rates, is a pure capitalist interest rate and its allowed free movement. Enhanced participation and trading in Sonia by time changes will see terrific volatility in days and months ahead to all UK financial instruments.

Brian Twomey, Inside the Currency Market, btwomey.com, brian@btwomey.com

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