Pressure mounts over Brexit terms
Morning mid-market rates – The majors
22nd November: Highlights
- Brexit is damaging the UK economy
- Banks beginning to tighten lending standard to offset recession
- Conditions are close to being in place for a smaller hike in December
GBP – Government facing criticism over post-Brexit conditions
A Swiss-style arrangement has been discounted by the Conservatives and labelled a non-starter by Brussels. One of Boris Johnson’s only achievements as Prime Minister was to engineer a Brexit deal that satisfied the right wing of his Party, even though it is now considered unworkable.
The most demanding effect of Brexit has been the shortage of cheap, dependable workers to undertake roles that traditionally have been low-paid, repetitive and physically demanding.
To persuade British nationals to fulfil these roles, the salaries have had to increase, sometimes by double. This has contributed to inflation, and even then, the shortages remain.
The Labour Party leader Sir Keir Starmer spoke yesterday of the need to wean the country off its reliance on cheap foreign labour, but in true Labour style, he omitted to say how he believed this could or should be done.
The OECD reported yesterday that it believes that the UK will suffer the greatest contraction of the most developed economies due to a series of unique circumstances.
It believes that the shortage of workers and the elevated level of untargeted energy support payments will see the recession last longer and its effect will be tougher than other economies.
The UK economy is expected to shrink by 0.4% in 2023 and grow by just 0.2% in 2024. With an election due at the end of 2024, the pressure on the Government to show an improvement to voters before they head to the polls will be unbearable and may lead to a further backbench rebellion.
The Pound was unable to continue its recent rally against the dollar yesterday, as the Greenback reacted to news that there have been more deaths in China from Covid-19 and stay-at-home orders have been issued for twenty-six districts of Beijing.
Sterling fell to a low of 1.1778 and closed at 1.1820.
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USD – Labour market needs to slow gradually, as a first step
The odds of the country falling into recession have lengthened over the past few weeks as inflation has shown signs of abating.
Now, if Jerome Powell can be persuaded to lift his foot just a little off the brake pedal at the next FOMC meeting, the Fed can achieve that goal of avoiding a damaging downturn.
Virtually the entire financial market understands the need for employment to slow gradually. Until it does, the fear will be that it goes from red-hot to ice-cold in a couple of months. For that reason, the November NFP report, due for release a week on Friday, will take on greater significance.
Early estimates are for a marginal fall in headline job creation, although those are based on little more than a mixture of speculation and wishful thinking,
The primary events that need to happen for a recession to be avoided are: GDP to remain below potential. A further fall in job openings to discourage job hopping. A commensurate fall in the level of wage growth. A fall in inflation back towards the Fed’s target of 2%.
If the first three events take place, the fourth should happen naturally.
Data for durable goods orders will be released tomorrow. When the economy is performing well, this data goes by without any real attention being paid. Still, when there is uncertainty, traders look for trends to understand the likely productivity level.
A comparable situation exists with jobless claims. Over the past few months, claims have fallen to well below the neutral level of around 200k new claims, translating into a strong employment outlook.
Now that the average is around 225k, markets are awaiting an equal fall in job creation, which makes the November employment report significant.
The dollar index reacted to a fall in risk appetite yesterday by retracing the correction it has suffered for the past ten days. It rose to a high of 108.01 and closed at 107.82
EUR – Rates need to become restrictive to ease inflation
That provides the market with a certainty that the Central Bank will perform another jumbo rate increase at its next meeting, which is due to take place in the middle of next month.
Rates are still accommodative even after the ECB’s actions at its recent meetings. Now that Lagarde’s first goal of moving interest rates into positive territory has been achieved, the next is to lift them to a level where they discourage borrowing. This will decrease demand and inflation.
So far, there has been no suggestion that inflation will begin to fall over the next two or three months. The first reason is seasonal. Winter always sees inflation rise due almost entirely to the energy demand.
As that demand subsides, the effect of ECB actions may be seen. Still, several one-offs are in play, particularly the effect of the price of foodstuffs due almost entirely to the continued conflict in Ukraine.
While prices have risen, no significant shortages have yet been reported.
The Eurozone is slowly edging away from a severe recession. The fall in the oil price over the past few days, driven by the hope that Saudi Arabia will increase production has been positively received.
The efforts of Germany to limit energy usage are having a positive effect, while, so far, the oncoming winter has been milder than is usual.
While these factors are creating a degree of positivity, no one in Brussels or Frankfurt is under any illusion that the situation can change rapidly.
The Euro’s recent rally has ended abruptly as the dollar’s outlook turns positive. It fell to a low of 1.0222 yesterday and closed at 1.0241
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.