12 August 2019: “Brexcession” moving closer

“Brexcession” moving closer

August 12th: Highlights

  • UK GDP contracts in Q2
  • No need for a further cut but Fed may accede to market need
  • Eurozone GDP to also presage a recession?

Big week for UK data following news of shrinking economy

The data released in the UK, together with last week’s rumours of a snap General Election being called, pushed the pound to levels not seen for 2 ½ years versus the euro and close to the 1.2000 level versus the dollar.

Friday’s GDP data showed that the economy contracted for the first time since 2012 and was far weaker than analysts expected. The economy shrunk by 0.2% in the period between April and June. With no-deal becoming more likely every day as both sides blame the other, a second quarter of contraction looms. Two consecutive quarters of negative growth officially confirm a recession.

While it is obvious that a recession in the UK is most likely caused by concerns over a no-deal Brexit, the parlous state of the global economy is no doubt is partially to blame. The new members of Boris Johnson’s Cabinet appear to be “singing from the same hymn sheet”. This is at least heartening from the point of view of presenting a united front but there are still major economic and political hurdles to be negotiated.

This week, employment and inflation data will be released in the UK. The Bank of England will be particularly concerned over inflation. It is improbable that wage inflation will continue to grow but with the pound continuing to weaken, inflation may rise further. This will place the Central Bank between “a rock and a hard place” when deciding future policy.

It is impossible in the current environment to make a case for anything other than a continued weakness for the pound, punctuated by shorter periods of profit-taking. With the medium-term target of 1.2000 versus the dollar likely to “fall” at any time, the next objective for traders will be the 1.1806 low from October 2016.

The pound fell to a low of 1.2023, closing at 1.2028, versus the dollar on Friday and a low of 1.0732 versus the single currency, closing at 1.0739.
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Traders seeing fire without smoke

If it was the intention of the FOMC to keep the markets off-balance at their meeting at the end of July, they appear to have succeeded. It was the popular view in the run-up to the meeting that the Fed’s decision would be for “one and done”. That is to say, one rate cut to provide “insurance”, then “business as usual.

The rhetoric, or “advance guidance” provided by the Fed. Chair Jerome Powell, has confused the markets and thus led to a period of doubt which has seen the dollar continue to correct. In all probability, the Fed.’s message was just as expected but there remains a lingering doubt that another cut may be signalled if not enacted at the next meeting.

Analysts will be awaiting the minutes of the meeting that will be released on 22nd August. If there is to be a rally in the dollar it will most probably only take place once the views of several less hawkish members of the FOMC have been made clear.

This week’s data is dominated by the release of inflation data which is expected to remain unchanged YoY at 2.1%.

Retail sales figures will give some indication as to how the consumer is holding up but with employment data continuing to see new jobs created at a consistent rate, it is unlikely there will be any concern for the Central Bank.

The dollar index remained in a narrow, if weaker, range last week, trading as low as 97.21, closing at 97.58.

Eurozone GDP to predict a recession?

The Eurozone has been much more severely affected by the slowdown in global activity than the UK, but they have a common enemy which is slowly sucking growth and activity from their economies. That common thread is Brexit which has been considered a uniquely British issue over the past three-plus years.

As the new British Government starts to exert pressure over the most contentious parts of the Withdrawal Agreement, most obviously the Irish Backstop, Brussels suddenly appears to be in a weaker position. The borders that the EU has (five of them) with Switzerland, all of which are “soft” and have been ever since the “four freedoms” were enacted are leading to questions being asked about the insistence on an official arrangement for the island of Ireland.

One further complication, should no deal become a reality, is the likely refusal of the UK to pay the “divorce” payment of Eur 39 billion which had been agreed pending an overall agreement.

With President Trump still “considering” a 20% tariff on imports of vehicles into the U.S. that have been manufactured in the EU, this week’s Q2 GDP data for individual countries as well as the entire region will attract significant attention.

Should Germany, which reports its Q2 data on Wednesday, report a contraction as many analysts expect then it is also likely that the Eurozone will follow suit when it reports later Wednesday morning.

If the data is as weak as analysts expect, the 1.1000 level versus the dollar could be under threat.

Furthermore, should there have been a contraction in Q2, given the continued poor data, global issues, and the Brexit issue, it is probable that the Eurozone will be officially in recession at the end of Q3.

Last week, the euro reached a low of 1.1104 but closed at 1.1201.

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.”