Hugh Hendry On The "Near Certainty" Of European Interest Rate Rises

Tyler Durden's picture

Europe risks getting it wrong again on rate rises

From Hugh Hendry, posted first in the FT

The euro project has not gone according to plan. It reminds me of the story of the James Bond character Q, based on the British intelligence officer Charles Fraser-Smith. It was he who invented a compass for spies hidden in a button that unscrewed clockwise. The contraption was based on the simple yet brilliant theory that the unswerving logic of the German mind would never guess that something might unscrew the wrong way. This is really what happened with the euro. New member states were supposed to take lower German interest rates and invest their resources wisely to improve and deepen their productive capacity. Instead, they used the advantage to finance speculative asset bubbles. The peripheral nations of Europe turned the wrong way. The Germans are unhappy.

But, desperate to cling to monetary union, the other European sovereigns have opted to default on their spending promises to voters rather than impose a haircut on their financial creditors. In the 1920s the pay-off structure had been very different. The first world war took an intolerable toll on the typical household both in terms of the loss of life and financial well-being; everyone had become poorer. Accordingly, there was little willingness on the part of the ruling political class to force austerity measures to redress the fiscal imbalances. The people had suffered long enough. Consequently, there was much procrastination and fiscal deficits persisted way beyond the end of the war, making capital markets reluctant to accept the waning security of government paper and forcing the sovereign to rely on the central bank’s printing press.

This time around, however, the political class has concluded that the Greeks (especially the Greeks!) and the other peripheral states have done so well off the back of the euro project that it is their turn to shoulder the burden. They calculate that the social pain would be less severe than the financial costs of a debt default and/or a euro exit. Of course, this is to neglect the financial consequences of bailing out the financial sector in 2008 and its ensuing impact on the ordinary household. Can an analogy be drawn between the first world war and the banking bail-out? Certainly both events had a disastrous impact on the sovereign fiscal balance. Consequently the social mood has darkened considerably. Emotions run high and the term speculator has even become pejorative. Today’s non-financial media are clearly of the opinion that the people have suffered enough.

Ireland is indicative of the social pain. Nominal incomes have already fallen substantially and the working population has endured severe job losses and wage cuts. Their reward is a second austerity package. The average household is now being asked to pay additional taxes, minimum wages are to be cut further and more job losses are a virtual certainty. The country itself is only held together by the premise that the economy will grow by 2.75 per cent a year for the next four years. Dream on.

I believe the European bureaucrats have badly misjudged the public mood. Perhaps they are too closely aligned with the plutocracy of the financial and banking sector. Contrast the mood of the ordinary household with that of my rich hedge fund friends. Today the average European long/short fund is running its most bullish risk exposure in many years and is feeling ebullient regarding the rising tide of corporate profitability as businesses pare back employment levels. My grumble is that I suspect the omnipotent powers of my peers’ central bankers might be found wanting just when they are needed most.

For the shadow of policy error lurks once more. The European Central Bank’s president even proclaimed his satisfaction with his bank’s decision to raise rates back in the cauldron month of July 2008. I salute him for his willingness to subject the bank’s decisions to open scrutiny. But tightening monetary policy amid the deepest economic crisis of the past 50 years was perhaps not his institution’s finest hour. And with headline inflation rates being boosted by relative price rises in the commodity sector, as Chinese policymakers continue to plug 10 per cent into their GDP calculators, another poorly-timed rise in European rates cannot be so easily dismissed.

The markets are already pricing in the near certainty of a quarter-point rise from the Bank of England by May with another increase expected before October. But perhaps not wanting to be left out, the zealous guardians of Europe’s monetary system, who measure inflation rates across the 17-country bloc to the second decimal point, have recently raised their rhetoric to such an extent that investors are openly speculating that in spite of the continent’s tight fiscal policy European rates are now likely to rise before the end of summer. As they say in the land of macro investing, the cycle isn’t over until the Europeans lift rates. Just don’t bet on money staying tight for long.

h/t Johan


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asdasmos's picture

Hugh's analysis is always greatly appreciated.


Interesting commentary, but what will the metals do?

JW n FL's picture

metals? if you own metals for an investment... you should sell.

The Talmud Kid's picture

I'm long physical gold and short GLD.



samslaught's picture

metals always trend up when rates are below the real rate of inflation, metals go up exponentially as rates rise but are still below the real rate of inflation.  Once rates surpass inflation metals will trend down.

huggy_in_london's picture

whats the "real rate of inflation"?   hahaha

CrashisOptimistic's picture

That's not important.  What is important is what will oil do?

CPL's picture

I think we are all waiting for the day oil and food prices are included in inflationary rates since both account for a large percentage of how anyone in the first world (soon to be third) spends their money. The interest rate hikes are just a position to increase revenues on the back of food an oil.

Pretty hard throwing double digit interest rates and not expect the market to price it directly into the cost of "soft" goods like oil and food. Mainly because modern farming is an example of how credit is used for cash flow management and the oil industry uses credit for capacity expansion.

Either way, Crash or choke. We will see bad comes from either direction of stagflation or inflation, with or without credit/interest increases.

Like watching someone playing chess and the options are hop around the board like a loon or pick 20 ways to get pushed into check mate.

TheGreatPonzi's picture

There won't be any rate hike, sorry to spoil the party.

Americans have an idealistic view of Europe, which would be less corrupt, wiser, and more inclined to austerity rather than money printing.

The truth is very different. Don't let the words of Trichet or Hoenig fool you. If the Ponzi is at risk, rest assured inflation won't be anymore a problem for them.

Furthermore, the entire financial establishment and the press have engaged a campaign against rate increases:

Phineas Gage's picture

I agree.  A rate hike by the BOE by May seems unlikely.

huggy_in_london's picture

won't matter... the market will do it for them.... Who wants to lend money at zero when inflation running at 5%?  No one... thats part of the reason why banks wont lend.....

Popo's picture

There will absolutely be a rate hike. You're operating under the false premise that central banks control rates over the long term. They can't and they don't. The bond market sets the rate. Period.

When Ireland defaults -- which they will -- rates will jump. Watch.

TheGreatPonzi's picture

I am talking about central bank rates, just like the writer of this article.

"The markets are already pricing in the near certainty of a quarter-point rise from the Bank of England by May with another increase expected before October."

If you want to discuss general bonds rates, there are other articles on ZH for this.

Popo's picture

Uh... Hello? I'm also talking about central bank rates.

Central banks *follow* the market (despite the propaganda that they don't). In terms of raw numbers, international CB's are the weak force and debt markets are the strong force. CB's will always ultimately follow the market because the market forces their hand.

Ie: The Fed didn't "accidentally" raise rates in the 1930's depression as Fed annointed economic historians would have you believe. The market forced their hand. A troubling fact that the man behind the curtain does not want the public to know.

samslaught's picture

Interesting?  Can you expand on this more?  I've never heard anyone say this but it makes sense. 

buzzsaw99's picture

This may sound backwards but my thinking goes like this. Let's say the eu stock markets start to weaken. If the markets crash while rates are at zero there is nowhere left to go and the omnipotence aura loses its mystique. They could raise rates as a cover for some selling, deleveraging, profit taking, whatever. Then, when the selling was done they could lower them again and the tail wagging the dog doesn't show.

Bigger Dickus's picture

Nope, that's not important either.

The real question is "what would Brian Boitano do?"

Dollar Bill Hiccup's picture

I don't think it's a question of forecasting on Hendry's part. Simply that one side of the boat is very crowded, so that if there is a policy mistake and rates rise, then ... whoops. The lower probability event is the event to be concerned about.

The Talmud Kid's picture

Will anyone still care about fake money by then at all?

Mitchman's picture

So nice to hear from Mr. Hendry again.  The Germans will not sit idly by while inflation nips at their heels.

ElvisDog's picture

I don't know, the Germans have rolled over so far, buying into the $750B Euro stabilization fund for instance.

Oh regional Indian's picture

Huge Hendry has it nailed.

Huge, systemic trouble ahead. 

In the big picture though, a UK rate hike makes sense from the controller standpoint.

Money will rush into pounds, which they will promptly use to buy more UST. Perfect. The weird uptrend in UK buying UST is explained AND enabled.

Wheels within wheels. They'll only come off when the track finishes or system goes unstable.


Hephasteus's picture

I like your post but I submit to you a simpler explanation. You are wiped (the amnesia) you speak of to be put through a ringer. A ringer that wants to know how to lie to you and get you to believe it. Continually wiped and lied to and this is why you see so many fooled and idiotic people. They are the successes of the process. But theres obviously quite a few failures going on.

Yes huge trouble ahead. First rush to gold by the insiders and rush out wasn't enough wealth transfer. We are stuck in a well. The powers that be do not have sufficient resources to continue onto their next endeavor (green). They haven't stolen enough. There has to be another big transfer of wealth.  I gotta say I'm really nervous about this one. Not sure if people can be forwarned and forearmed well enough.

Oh regional Indian's picture

;-) Thanks for reading Heph. That ringer is called Maya around these parts (where I live). Delusion!

I like the thought that the green revolution was underfunded from the TPTB side. A whole new spin! The robber barons need a loan!


Hephasteus's picture

Oh regional indian. Yes. I know quite a bit about all things from your country. I know a few astrologers from your parts and a few citizens and all of you're mythology and religion. In fact it's called illusion of maya. ;)

Oh regional Indian's picture

Good to know Heph. Sidereal astrology had the whole precession thing (recently a big fuss) sorted out in its root/start.


ElvisDog's picture

Oh my Lord, a 1/4 point increase now and another in October??? Hells Bells what a dramatic stand by the ECB.

Hephasteus's picture

Replay. They are going to jawbone and jawbone and jawbone raising interest rates to drive people out of precious metals. They are going to raise interest rates and signal to everyone to get out of metal and get back into the fake interest bearing accounts. They are going to drop the interest rates as soon as you do this. This is all happened before. Everybody remember the pivotal "mistake" that the Bernank is focused on. The mistake of raising interest rates 3 times in a week and then crashing them back down pissing everyone off. What is he going to do differently this time? Raise them and hold it for a week or two before crashing them back down. Everyboy pay attention to that particular historical event. The game comes down to that play and how they do it differently this time.

Pay attention.

hammel123's picture

>The mistake of raising interest rates 3 times in a week<

confused here

Hephasteus's picture

Ok here's what happened. Australia was in trouble, big trouble. They raised interest rates and sucked capital into the country. This buckled europe and US a bit. They raised interest rates. US raised interest rates 3 times in a week. This sucked capital back into the US. They then preceed to dump back to zirp. This pissed of EVERYONE they ran right back into gold and set off the double dip.

This moment in history is frozen in Bernanke's mind. He's a robber. He's focused on the big score. The ability to pull off MASSIVE heists. This will give the illusion that downturns are not part of some big scheme and just rare occurances that you don't have to worry about. This is why the 80's crash and the dotcom bust were so small. They stole a little but not enough to make it to end game of the IT revolution. They have to pull the big score that went haywire during the great depression. Bernanke is fixated on this particular point in the strategy of it. Remember during this crash what has been different. Well one thing different is Australia went up a 1/2 percent very very early in the game. To avoid and prolong their necessary alarming defection. Now we get a chance to see bernanke's move. What they do differently this time? Study the great depression. The person robbing you has.

speconomist's picture

With the exception of the latest 3 paragraphs, all was published in his December's Newsletter from Eclectica.

Popo's picture

> "I believe the European bureaucrats have badly misjudged the public mood"

Hendry's analysis of the health of the banking sector is impeccable. But his sentiment analysis is god awful. The reality is that German business confidence just clocked another multi year high. Yes, it means the German public is uneducated (if not outright oblivious) to the problems with the economy. But Hendry is equally oblivious to the business sentiment metrics.

I like Hendry, but he forgets that his perception of the coming storm (which is completely valid and IMHO correct) is not at all widely shared by the general public - at least not yet.

CPL's picture

That's because the human herd is educated with an inner tube and a banana

The Talmud Kid's picture

We're still working under the assumption that gvt numbers are accurate?

Since when?

huggy_in_london's picture

sorry but is there *really* still a need for rates to be at the emergency levels?  No, there isn't ....

Cpl Hicks's picture

Well, folks, there you have it...

"Emotions run high and the term speculator has even become pejorative..."  Big whoooOOOooo!

Then again, maybe that's just speculation.