11 June 2019: Sterling facing “double trouble”

Sterling facing “double trouble”

June 11th: Highlights

  • Economy slowing as no deal Brexit fears take hold
  • Traders remain unsure over dovish Fed.
  • ECB policy cupboard is bare, global issues to drive euro

Ten candidates to face the first poll on Thursday

The nominations for the leadership of the Conservative Party closed last evening. There were no shocks among the candidates who were able to show the support of the requisite six MPs in order to be able to stand.

Of the ten official candidates, former Foreign Secretary Boris Johnson remains the favourite to win the race. However, his favouritism has made him a target for the other candidates who agree he is the man to beat.

While the leader has no time limit on his spell in office, he or she will be expected to lead the party to victory in the next General Election which has to be held in 2022. That is where any long-term planning ends and the entire process will be fought over Brexit which is by far the most divisive political issue to face the country since Margaret Thatcher’s trade union battles.

While the Government comes to a standstill as the Conservative Party go through their election, the economy is showing signs of also grinding to a halt. The signs have been there for some time with a tell-tale slowdown in consumer activity. This is often a precursor of a more general fall in activity as purse strings are tightened as fears over employment row.

Yesterday’s manufacturing and industrial production reports for April were expected to be weak and they lived up to expectation. Industrial production contracted by 2.7% while manufacturing fell by 3.9%.

Month on month GDP data showed that overall the economy contracted by 0.4% in April.

Today’s employment data is now expected to be weaker than had been previously expected with the possibility that the unemployment rate may have increased from 3.8% to 3.9% or possibly 4%

Sterling remains in the thrall of Brexit and the gyrations of the dollar. Versus the greenback, it fell to a low of 1.2677 yesterday, closing at 1.2680. Versus the euro, it continued its recent fall, reaching 1.1197. It closed at 1.1215.

With Brexit, as seen through the lens of the leadership contest, and a significantly weakening economy, the pound could be in for a rough end to Q2.

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Friday’s data quickly absorbed

Those who are bullish of the U.S. economy (although even they are looking at growth in comparison to other G7 countries) have quickly agreed that Friday’s appreciably weaker than expected employment report for May was yet another outlier. We have now seen “outliers” in the past two months, however, the three month average of the data as originally reported remains around +180k new jobs.

The kneejerk reactions to the headline employment report remain the “froth on the cappuccino” since, as an indicator, it has no value. The Fed. and most serious analysts look at the trend over the longer term.

There is little doubt that the U.S. economy is slowing. But the jury is still out on whether that is a longer-term trend or simply a rough patch. A problem that the economy faces under the current administration is that the Fed. is being harassed by a “back seat driver” in the shape of the President. It must be disconcerting for Jerome Powell to have his decisions (made in conjunction with the FOMC) constantly analysed by both the professional analysts, (who have very long memories) and a President who prefers to “shoot from the hip”.

The perception of the performance of the Fed. Chairman is an indicator of his ability to act when the chips are down. Will he be able to reverse the decision to raise rates last year if the situation requires it? So far, the answer to that must be yes, as Powell has shown himself to be both “in control” and prepared to act in the best interests of the country and not necessarily by trying to curry favour.

The dollar index recovered from Friday’s data yesterday, arresting its recent slide. It closed higher at 96.79 having earlier reached 96.93.

Tomorrow’s consumer price data will provide further evidence of the state of the economy although YoY inflation is unlikely to have moved away from last month’s 2.1%.

The greats know when it’s time to go

ECB President Mario Draghi will leave his position in a few months’ time. He has been a spectacularly good firefighter and his “whatever it takes” speech when talking about saving the euro will be considered a major turning point in the fight against the global financial crisis.

However, has he been as good a “peacetime general” as he was in wartime? The conclusion to that argument will be left to history.

Could the ECB have raised rates last year when they had the chance? Was Draghi too dovish in his perception of the economy, erring far too far on the side of caution? Has today’s lack of policy alternatives been a direct result of failure to act, or has the ECB simply been unlucky?

As the global economy falters, it is easy, almost too easy, to sit back and say, “we did all we could”. That may be right, but the ECB President’s hands are tied by two further issues.

First is one of Sr. Draghi’s favourite sayings “we are only interested in economic data for the entire region”.

While that is how things will be in the future when the Eurozone is more mature, in the current environment, it is tantamount to worrying about a broken windscreen wiper on a sunny day when one of the wheels has fallen off the car. The major economies are the ones that need the most support to ensure that their success feeds down to the entire group. That has clearly been an issue that a more hawkish President would have handled differently.

Second are the structural issues that now face a tough passage through a new and more fragmented European Parliament where deals will need to be done.

The Eurozone is at a crossroads; does it stick with the progress it has made or move on towards greater integration, which ironically may make it more isolated in global terms.

For now, the economy is very close to the bottom despite the ECB’s inability to act, but in the short term, a lot will depend on the outcome of this week’s G20 meeting.

Having reached an agreement with the low hanging fruit in the shape of Mexico, President Trump is now threatening China with further tariffs should he not be able to see the Chinese President for talks at the summit. That would be a setback for global risk appetite and would probably manifest itself in a weaker euro.

Yesterday the single currency reacted to a stronger dollar by falling to a low of 1.1290, closing at 1.1311.

Have a great day!

About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”