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Peek Ahead: Surprise! It's the central bank

Published in Automated Trader Magazine Issue 36 Spring 2015

Central banks are full of surprises. Remember when Switzerland's central bank unpegged the franc from the euro? You might have seen a little news story about it here and there. The euro and USD plunged almost 30% against the franc immediately after, causing chaos in FX markets around the world.

More hilarity ensued. In Europe, the European Central Bank, Denmark, Switzerland, and Sweden have imposed negative deposit rates, with the latter becoming the first to make its main repo rate negative.

Asian economies are dropping rates too. Thailand, South Korea, China, India, the Philippines, Indonesia - all surprised markets with rate cuts. More central banks are expected to join the party.

Before even these dominoes fell, Japan's "Abenomics" announced a bigger yen bazooka via its QE programme, as well as a major rebalance of its pension fund holdings to favour more equities, both foreign and domestic. It was the latest attempt to beat out a decades-long rout of stagflation.

A Japanese asset manager told Peek Ahead that in Japan, earthquakes may be trouble but central banks are "even more so dangerous".

Which brings us to the Fed and pressure to hike interest rates. What combination of economic figures exactly do the chicken gut diviners need to see to hit the button?

It's possible that in a central bankers' ideal world, patience would last until infrastructures intended to make the markets safe are running smoothly in compliance with finalised regulations, some of which target algos directly.

Central banks have been through the bilateral Wild West, and look how that turned out. But they don't want to go blindly into the electronic space either, perhaps there's been some lessons learned from the gaping holes in US equity market structure. One can hardly blame the developed world's central banks for wanting to influence the market they have become major players in during this historic era of monetary policy.

Which might lead one to the conclusion that lifting interest rates isn't about the economy. It's the infrastructure stupid.

Unfortunately, pressure is building faster than the thousands of pages of regulation can get written, approved and reasonably implemented - think Basel III, Volcker and Vickers Rules, MiFID II, Dodd-Frank, et al.

Trade repositories seem to be ready at a global level. But in other ways, the US is way ahead of Europe. Swap Execution Facilities, for example, are like leashed dogs, ready to hunt for rates and credit liquidity. New venues mandated in Europe, like Organised Trading Facilities, are hardly understood yet.

Meanwhile, the ECB is only just starting with its €1.1 trillion bond purchasing programme, but the Bank of England is feeling the heat just like the Fed as the UK's unemployment drops and inflation hits zero percent for the first time since records began.

What that could mean is a return to betting on interest rates before rules governing new trade and post-trade infrastructures are signed off on, against the back drop of an increasingly volatile economic environment. The "taper tantrum" of 2013, which seems to be coming up again as US employment figures show sustained strength, provides one example of what the markets might have to deal with.

Potentially devastating for emerging markets, and a strain on infrastructures.

Artwork by WilliamBanzai7: a Hong Kong based digital artist specialising in financial markets satire. He can be followed and contacted on twitter: @williambanzai7