13 July 2022: Ideas wanted

Ideas wanted

13th July: Highlights

  • Sunak gains key backers
  • Economy in downturn, but no one has told jobs market yet
  • Parity tested as recession fears grow

GBP – Entirely predictable tax promises won’t fix the economy

The race to be Conservative Party Leader has got under way in earnest, with eight candidates passing the first test of gaining the support of at least twenty Members of Parliament.

The two most significant fallers at the first hurdle were Transport Secretary Grant Schapps and one of the two Cabinet Ministers who are seen as the instigators of Boris Johnson’s position becoming untenable, Sajid Javid.

The leaders in the race are former Chancellor, Rishi Sunak, and current Foreign Secretary Liz Truss. Schapps and current Deputy Prime Minister Dominic Raab have declared their support for Sunak while Leader of the House, Jacob Rees-Mogg, favours Truss.

The first vote will take place at 1.30pm today, candidates required to receive a minimum of thirty votes to be able to remain in the race, although the one placed last will be dropped. A similar vote will take place tomorrow, with a third, if necessary, taking place on Monday.

The new Prime Minister will have a full slate of issues to deal with from day one when he or she takes over in September. Brexit and the Northern Ireland Protocol are still in need of clarity, while the cost-of-living crisis is unlikely to have abated, especially since the Chairman of Ofwat the electricity regulator spoke recently of the fact that the expected increase of £850 that was expected in the energy cap in the Autumn is likely to be nearer £1,200.

During Johnson’s term in office the rise in National Insurance payments that was announced in last November’s budget was apparently fully supported, but now that Cabinet members past and present are free to express their opinions without fear or favour are expressing their true beliefs.

The new Chancellor will face a turbulent period in which he or she will have to reconcile the new Prime Minister’s pledges on taxation with the monetary policy actions of the Bank of England. While it is right and proper that the Central Bank is committed to bringing down inflation, the new world order is likely to be such that a target of 2% for inflation is no longer viable.

It is likely that, on average, official interest rates will settle at a higher level in the medium to long term than has been seen recently. It is clear that rates at close to zero can hamper the Bank’s ability to be flexible in times of an economic downturn.

The pound saw a continuation of its recent fall versus the dollar yesterday. It reached a low of 1.1807, but bounced back to close at 1.1886. Versus the euro, Sterling has feared a little better as the euro has raced to touch parity versus the dollar. It reached 1.1859 and closed at 1.1845.

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USD – Cries of too much too soon ring around Wall Street

On Wall Street, economists and analysts are beginning to feel the heat from their employers to toe the line and send out market commentary that is more in line with the bank’s corporate view.

While such practices have been happening for many years it is now with the Federal Reserve on a path to hiking rates that is damaging to stock market returns that it is deemed necessary.

With sales forces finding reaching their targets more difficult by the month and in-house analysts pumping out unhelpful research about the need for higher interest rates despite fear of recession, something has to give, and it is likely to be the slant given to research which is anything but independent and will comply more with the house view.

There has long been a degree of scepticism about banks talking their books and a balanced view has always been recommended, but such a thing is often hard to find.

The Federal Reserve remains committed to continuing to hike interest rates, and it is considered fairly certain that there will be another seventy-five-basis point increase at the next FOMC meeting. Apart from comments from Ester George from the Kansas City Fed recently, the other members of the committee have generally favoured tighter monetary policy.

Richmond Fed President Tom Barkin spoke yesterday of his belief that there is a path to cool inflation, but it will bring a recession dangerously close.

The evidence of the latest employment report indicates that if there is to be a recession, that the labour market remains blind to that fact.

Several members of the Fed have been saying that they are willing to be driven by the data, so today’s inflation report for June and the upcoming first cut of GDP for Q2 will be of particular interest.

It is possible that there will be a marginal fall in core inflation when figures are released today, while the headline is expected to be unchanged at 8.6%.

Were Q2 GDP to be negative, the U.S. would technically be in a recession when using the traditional two quarters measure. This could possibly have an effect on the Fed’s thinking as it will bring current growth into focus, but it is unlikely to slow the pace of interest rate increases.

Yesterday, the dollar index continued on its path towards 110. With the euro touching parity, the markets are beginning to look a little overstretched, and it could be that a correction may need to take place. The index reached a high of 108.55, but actually closed five pips lower on the day at 108.15.

EUR – Euro hits lowest level since 2002

It had been talked about for some time, at least most of this year, but yesterday the single currency touched parity versus the dollar before it attracted buying interest from those traders who have been short of euros as a core position for several months.

The question is what now? There have been a number of reasons why the currency has been weak, not least of all the war in Ukraine that has badly disrupted supply of basic foodstuffs and the energy crisis that has contributed significantly to rising inflation and the cost-of-living crisis.

With both those issues unlikely to abate anytime soon, it is possible that the euro will fall through the thin layer of support that now exists at parity, although the picture is a little clouded by the upcoming ECB meeting and the hike in interest rates that will bring.

The market remains unconvinced about the inflation fighting credentials of the Central bank as a whole, despite pockets of hawkishness displayed by first Germany and more recently Austria.

The choice facing Christine Lagarde is firefly stark. If the hike is fifty basis points, the fall in the euro will abate somewhat, but it will still be to the Federal Reserve, which has shown far greater commitment to fighting inflation.

Were the hike to be just the twenty-five points, known to be favoured by Lagarde, the euro would move lower at a rapid pace, since the ECB’s commitment to lowering inflation would be severely questioned. Furthermore, it could bring about the start of a structural realignment since a number of nations, the Baltic States, for example would side with the Frugal Five to bring about real change.

Looking back, a lot of the blame for the current plight of the ECB can be laid at the door of former German Chancellor Angela Merkel. Her insistence that Germany had to be head of the European Union saw the wholly unsuitable Ursula von der Leyen appointed as EU Commission President and left Bundesbank President Jens Weidmann, who had been considered a shoo-in to replace Mario Draghi, high and dry.

The appointment of a political candidate in Christine Lagarde has led to a confused set of policies that have, in the end, favoured no one.

The next few weeks will be critical for the euro. It is possible that it will be able to resist parity until the ECB meeting next week, but that will prove to be the acid test.

Having touched parity yesterday, the euro managed to rally back to 1.0037, but the pressure will remain.

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.”