The ECB joined the BoE, and the central banks in Indonesia and New Zealand (and Australia on Tues) in keeping interest rates unchanged as while some acknowledge the inflation risks, the economic landscape has clearly changed. The most interesting response was in the FX markets after the Trichet comments. The sharp reversal downward in the euro vs the US$ after Trichet used his not secret anymore code words “strong vigilance” in hinting that they will raise rates again at the next meeting, points to the belief that it’s not always just interest rate differentials that drive a currency. The message is clear today, FX traders are worried that the European economy and particularly Greece, Ireland, Portugal and maybe Spain, can’t handle higher interest rates. The ECB is solely focused on inflation and from their perspective, REAL negative interest rates is not good policy and they want to normalize for that. Those with adjustable rate mortgages, among other interest rate sensitive products in the region, will have to adjust at a time when it won’t be easy.

The other function of course that the ECB has played, lender of last resort to the troubled banking system of Greece, Ireland and Portugal, has really muddied up the discussion over Greece because the ECB balance sheet is basically polluted with damaged goods and in response, they are very vocal on avoiding any debt restructuring. As the market impatiently awaits a resolution, the verbal spat between the ECB and the Germans has yields spiking today.

In the US, individual investor sentiment, according to AAII, has reached its most bearish since late Aug ’10, right before Dr. Feelgood supplied the market with another round of pleasure pills. Bulls fell to 24.4 from 30.2 while Bears rose to 47.7 from 33.4.

Category: MacroNotes

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