The currency vigilantes – putting theory into practice

Richard has written over the last couple of weeks about how QE is turning the world topsy turvy with potentially the higher inflation economies experiencing the lowest bond yields, how central banks and their printing presses are killing the bond vigilantes, and how the currency vigilantes are rising up in the bond vigilantes’ place.


Well the currency vigilantes have certainly been pummelling the bond vigilantes today. As UK QE expectations grow on the back of a combination of very weak UK money supply data and a dovish speech from Mervyn King, five year gilt yields hit an all time record low yield of 1.44% this morning, which leaves them yielding 0.20% less than 5 year German bund yields (see chart).  This is staggering if you consider that (a) Eurozone CPI is 1.8% vs UK CPI at 3.1% (and UK inflation is likely to remain elevated for another 15 months or so as VAT hikes work through the year on year numbers), and (b) German bunds have had a massive safe haven bid this year on the back of the European peripheral meltdown.


Meanwhile, on the currency front, so far today the British pound is down 0.6% against the US Dollar and 0.8% against the Euro. In fact, as the chart shows, sterling is the worst performing major currency in the world year to date, having fallen 2.5% against the US dollar.    [Note that there’s still some distance to cover before sterling is the worst performing currency in the world YTD, though – you didn’t want to hold currencies such as the Venezuelan Bolivar (-50%), the Guinean Franc (-29%) or the Ethiopian Birr (-23%)].

Discuss Article

  1. Trevor Rothermere says:

    What exactly is the MPC attempting to achieve with further QE?

    As you point out, gilt yields are already close to rock bottom. Driving them lower still will add nothing to people's propensity to borrow. Loan demand is constrained because people are deleveraging – they see an uncertain future and as such believe the prudent course is to pay down debt and save more. This is a rational response to the present circumstances.

     The psychology of the situation is this: the longer that monetary policy remains un-normalized, and the greater the non-conventional measures undertaken, the more the message is being sent out by the MPC that the outlook remains difficult and uncertain for the foreseeable future. With such an outlook, why would businesses choose to borrow money to invest, or consumers obtain loans to bring forward their consumption?

    Furthermore, and as you say, the market's response to further QE is currency depreciation. No doubt the MPC considers this a good thing, but the reality is that demand for the UK's exports is proving to be inelastic with respect to Sterling weakening. There is no export boom.

    Worse, the currency weakness ensures that an ever greater amount of business costs and household budgets are consumed by essential imports, such as energy, food and other commodities. Facing escalating costs, the rational response is to further batten down the hatches: reduce planned investment, defer consumption and hoard cash reserves in vehicles immune to currency depreciation (i.e. commodities).

    In an environment such as we have, where people are rationally choosing to deleverage, attempting to generate negative real rates will do nothing to spur either consumption or investment capable of productive returns.

    In his recent comments, the Dallas Fed's Richard Fisher has indicated he seems to grasp that the US Fed's actions may be being counter-productive to their aims. One can only hope that some enlightenment dawns upon the MPC's members before the damage they cause becomes too great.

    Posted on: 22/10/10 | 12:00 am
  2. Justin Pugsley says:

    UK 5-Year gilt yields 1.44% & UK CPI 3.1% says it all.  In real terms that’s a negative yield.

    Gilts have become a capital gains play and probably a speculative one at that with a bit of help from BOE.

    It reminds me of people doing buy to let, accepting negative cash flows (unsustainable in the long run), in the hope of bagging big profits.  This is beginning to look like a bubble, but one that probably still has plenty of legs as it will take a major catalyst to burst it and that’s clearly not here yet.

    Posted on: 22/10/10 | 12:00 am

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