23 March 2022: Sunak changes tack

Sunak changes tack

23rd March: Highlights

  • Sunak back in the spotlight
  • FOMC set to be more aggressive
  • The challenges continue to pile up

Spring statement supposed to be about regeneration

The Chancellor will deliver his Spring Statement to Parliament later today. It will be a vastly different speech to what he was expecting to make when he first started preparing.

Of course, he was under pressure following the decisions to increase national insurance contributions and lift the cap on domestic fuel prices but what has happened over the past six weeks or so has changed from concerns over what a build-up of Russian troops on its border with Ukraine to a full scale invasion that is likely to set the agenda for some time to come.

The sanctions that have been agreed against both Russia and President Putin’s acolytes will have repercussions for the UK economy in many ways that couldn’t have been imagined a little over a month ago.

Can Sunak be expected to bail out the public again? And if the answer to that question is yes, how much difference can he be realistically expected to make?

There is no way he can come to the rescue as he did when announcing the Government’s furlough scheme, and what he will announce later will be little more than tinkering in the overall picture of the economy.

A cut of five pence per litre in the duty charged on the forecourt price of fuel and a minor upwards revision in the starting level of pay on which National Insurance is payable will be easily swallowed up by the tsunami of added costs that are mounting on normal households.

The financial markets are beginning to price in a recession later in the year as the economy continues to adjust to the new normal. The hope is that if the country does indeed experience two consecutive quarters of contraction, the recession that indicates will be short-lived.

There is little doubt that the Russian invasion of Ukraine has changed the face of the broader European outlook, one that includes the United Kingdom, forever.

Russia even if it agrees to withdraw its troops from Ukraine will become a pariah state.

It is expected that at its next meeting, to be held on May 5th, the Bank of England’s monetary policy committee will vote to raise interest rates for an unprecedented fourth consecutive meeting. The Central bank has embarked on a programme of gradual increases to curb rampant inflation, but it may have made little progress in real terms when it next meets.

Market commentators have penciled in a pause following the next meeting while the Bank considers the effect of its rate hikes. It may be disappointed, however, since while the supply side inflation caused by the Pandemic may well be receding, the threat of growing wage demands could see rising inflation begin another phase.

The pound began the week with a more positive outlook. Yesterday it rose to a high of 1.3273, closing at 1.3262. Technically, it is now targeting resistance in the 1.3350 area.

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Powell vows to be more aggressive

Having, according to many observers, performed the economic equivalent of fiddling while Rome burns, the Federal Reserve may be on the verge of stamping on the brakes a little too hard.

Despite the mixing of metaphors, the comments being made by Chairman Powell and several of his FOMC colleagues sound a little like promises that now that the monetary policy feast is over, the famine is about to set in.

Over the past ten years, a period which roughly coincides with historically low interest rates, the Dow Jones Index has risen from 12,875 in June 2012 to a recent high of 36,952.

The fact that the expected neutral rate according to a few Regional Fed Presidents is below 2.5% will save the stock market from collapse, but that level of interest rate will certainly put a dent in several sure things and make investment managers work just a little harder.

It is hard to say whether the dominance of the market by Big Tech will continue, but markets will expect a little more than future growth predictions on which to base their investment decisions.

This will have a knock-on effect on pensioners too. An investment of $1,000 in the Dow in 2012 would now be worth $2,870. That is a more than significant return from an investment in blue chip stocks.

The change in the Fed from supporter of an ailing economy to inflation fighter has been swift, even though it could have been even more rapid. Concerns are growing that the Central bank may be pandering to the market, rather than making decisions based upon sound economic projections.

That having been said, for the next few months at least, sound economic projections may be difficult to interpret and will hold an element of subjectivity.

San Francisco Fed President Mary Daly spoke yesterday of her concerns that the country still has policy supported demand combined with weak and fragile supply chains, and this will continue to add to inflation.

There is a growing belief that having given the market a taste of what is to come the FOMC will agree to a fifty-basis point hike at its next meeting.

The dollar is still supported but is struggling to break higher despite risk aversion due to the conflict in Ukraine.

Yesterday, the index rose to a high close to 99 but fell back to close almost unchanged at 98.44.

Lagarde is still championing growth over inflation

ECB President Christine Lagarde received support in her recently uttered view that the Eurozone economy is not facing stagflation from one of her Vice Presidents yesterday.

Luis de Guindos, a former Spanish Minister of Finance and now a significant Presence at the ECB, spoke yesterday of possible risks to growth due to soaring inflation.

One issue that has become clear lately that will continue to confound any move towards greater integration of the Eurozone is the way that members of the Governing Council look at the Eurozone economy through the lens of their own national interests.

This may be predictable, but it means that the outlook for growth and inflation is skewed. While there is an underlying trend to continue to support the economy, mainly driven by Southern European States, the French Central bank Governor spoke yesterday of the need to concentrate on underlying inflation trends rather than the volatility currently being experienced by energy markets.

While the current trend in energy markets cannot be considered to be the froth on the cappuccino given how long the rise in wholesale gas prices has continued, this is a typically French view.

Francois Villeroy de Guindos agrees that it is time to take the foot off the accelerator but doesn’t see the need yet for the brake to be applied.

France wants to be one of the hawks like Germany or Belgium, its economic progress puts it in a group with Italy and Spain.

There is an election looming in France and support for the President, Emmanuel Macron is constant but his chances of being elected have been boosted by the emergence of another opposition Party that may split the vote.

There are still very few reasons to buy the euro unless it is interaction to risk appetite improving. Every rally appears to be seen as a selling opportunity, and this is hampering any progress.

Yesterday, the single currency rose to a high of 1.1045, but selling pressure took it down to 1.0960 before it recovered to close at 1.1028.

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.”