17 February 2021: Big tax rises? Not yet

Big tax rises? Not yet

17th February: Highlights

  • Sterling corrects but still likely to push higher
  • Fed bond purchases likely to continue
  • Confidence data belies economic reality

Sunak to allow recovery to take hold

As Rishi Sunak continues to prepare his budget which will be delivered on March 3rd, he is also preparing his long-term plans for repaying the debt that has been necessary to take on to combat the worst economic effects of the Pandemic.

Despite his not being a Party of taxation, it is inevitable that taxes will rise during the term of this Parliament. It is laudable but also somewhat theatrical to say that the country is going to grow its way back to financial health, but the reality is somewhat different.

The levels of growth likely to be seen over the next three or four years are expected to be healthy, but little more.

Although the issues with Brexit appear to be coming to an end and there is no doubt that the vaccination programme has been a major success story for the country, a significant post-pandemic shift in output across the entire economy would need to happen for taxes generated from businesses and individuals to be anywhere near sufficient.

Sunak will provide a degree of respite in a couple of weeks but make no mistake higher taxes are coming.

There is a £125 billion pot in household savings that is waiting to be unleashed when the economy reopens and that will provide a surge in growth, output and probably prices..

The Bank of England will have to keep its nerve in the face of a possible significant rise in inflation, wary that any change in monetary policy could derail the recovery. The relationship between supply and demand is set to change but this will be a temporary phenomenon.

The pound paused in its march towards the 1,40 level against the dollar in lively trade yesterday. It closed just two pips higher at 1,3907 having traded between 1.3951 and 1,3869.

Inflation data will be released later this morning with pressure still to the downside aided by a strong currency. The headline YoY number is expected to fall from 0.6% to 0.5%.

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Asset markets driven by impossible to value tech firms

The Fed continues to be fairly sanguine about the growth in asset prices across a wide range of markets. FOMC members continue to downplay the threat of a bubble.

St. Louis Fed President Fred Bullard commented yesterday that the markets continue to be led by big tech and no one should doubt their business models, future valuations, and strong revenue streams.

No matter, the significant rise in the value of Bitcoin must be becoming alarming for Central Banks, not just the Federal Reserve. The blurring of boundaries as one of the tech gurus, Elon Musk, almost validated the cryptocurrency is a major development.

This whole rise in equity values, no doubt buoyed by the Fed’s monetary policy and the continued QE, where $120 billion is printed every month, must end at some point and the steam will be taken out of the market.

The fear is that letting the air out of the balloon will happen all at once and markets will crash as inflation begins to turn eventually seeing rates and inevitably, borrowing costs rise.

There is expected to be a sign of continuing recovery when the data for January’s retail sales is released later today. A turnaround from a fall of 1.6% in December to a rise of around 0.75% is expected with the risk to the upside.

Even poor employment numbers are being disregarded to a certain extent. The level of confidence that President Biden’s stimulus package is going to be the panacea to cure all ills is fantasy although economists and analysts alike are prepared to be convinced.

With the economy now expected to be the first in G7 to reach pre-pandemic levels delivering on election pledges to his supporters will be one of Biden’s primary goals.

The dollar index is beginning to rise from the fairly strong base it has been building.

Yesterday, it reached 90.63, having earlier fallen to 90.12. There is a growing expectation that the low has been seen, as a rally, particularly against low-yielding currencies like the CHF and JPY, takes hold.

Economic sentiment is far stronger than expected

The Eurozone and ECB are prepared to treat any crumb of good news as a gold nugget as the Central Bank continues to hold back on any further action, using the hackneyed phrase about waiting and seeing.

EU Commission President Ursula von der Leyen has presided over the virtual destruction of faith and confidence in one of the Union’s largest partners across trade, security and intelligence sharing as she allowed first Brexit and then the vaccine fiasco to sour relations with London.

The EU has an issue with size. First, over the period of monetary union it has believed that one size fits all.

This is clearly not the case and led to the prolonged financial crisis that several members are still paying for both physically and emotionally. It then believed that the size of the trading bloc would intimidate the UK into accepting inferior terms over Brexit.

Finally, the EU sought to use its size and buying power to intimidate vaccine producers into breaking contracts with other buyers.

One of the prime reasons put forward for closer integration between the members of the EU was the massive advantage in tariff free trade between nations that was expected to accrue.

Germany for one, still relies on experts to grow and jealously guards its position in the global market without really trying to foster trade with its friends and neighbours.

Brussels believes that rather than trying to bolster trade with innovation that tying its members to an even closer Union will force compliance.

Ms. von der Leyen refused to be cowed by her part in the vaccine bullying instead commenting that she should be judged on her record at the end of her term.

Right now, she will have to virtually walk on water to have a bigger effect, good or bad on her reputation.

The euro began to correct as the dollar rose yesterday. It will be somewhat ironic, if this correction continues, since it will have begun on a day when economic confidence rose considerably, and data for GDP showed less of a contraction that had been previously expected.

It had been becoming top-heavy, over the past few sessions so a correction had become inevitable.

It fell to a low of 1.2096, closing at 1.2116. A break below 1.2040 will herald a test of 1.20.

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.”