25 February 2021: Markets discount negative rates

Markets discount negative rates

25th February: Highlights

  • BoE tones down positive rhetoric
  • Fed. Vice Chair sees brighter recovery despite dovish Powell
  • Lagarde’ positivity and Yellen’s dovish comments buoy single currency

Sunak to either extend furlough or suggest an alternative

The Government’s staged plan to reopen the economy as the number of infections continues to fall has provided a boost to the country both socially and economically. The vaccination programme has become self-fulfilling, with the infrastructure that has been set-up working very efficiently.

Next week the Chancellor will present his Budget to Parliament and that is when the realities of the damage done to the economy by the three lockdowns it has taken to bring the virus under control, will be laid bare.

Rishi Sunak is being pressured by business leaders, trade unions and the Opposition to continue several of the support measures that he has put in place.

It seems likely that the stamp duty holiday for property purchases will remain in place. In fact, there are even calls for it to be abolished entirely, since it appears to be an old-fashioned and outmoded form of taxation. Since it raised close to £12 billion in 2019/20 that is unlikely to happen since Sunak is trying to repair the country’s finances not, add to his problems.

The Confederation of British Industry has called for the furlough scheme that is scheduled to end on April 30th to be extended to coincide with the proposed complete lifting of restrictions on June 21st.

While that makes sense and has widespread support, it simply means that it will take that much longer for the economy to return to pre-pandemic levels.

Finally, the Federation of Small Businesses is calling for a higher level of support at the local level, in particular for the hospitality sector which was first into lockdown and will be among the last out.

All-in-all, next week’s announcement is likely to affect the country for years to come as Sunak battles to regain control of Government spending.

His meteoric rise to become favourite to be the next leader of the Conservative Party is likely to be tested as this, and future budgets, will bring in measures that are unpopular despite their necessity.

He will need to sugar coat the bitter pill of tax rises since he is bound to disappoint. The most believable rumours surround an increase in corporation tax mainly since the Prime Minister has discounted rises in income tax and any further cuts in public services.

Bank of England officials were on the wires providing their take on the economy yesterday. Jonathan Haskell spoke of his concerns that risks in the economy remain to the downside, while his colleague Ben Broadbent commented on the positive effect of Sterling’ recent strength on inflation.

The pound continued its recent rally yesterday but its rise to a high of 1.4243 was unsustainable and it fell back to close at 1.4137. It continues to make gains versus the euro reaching a high of 1,1708 completing a ten-day sequence of higher closes.

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Powell and Clarida: two sides of the same coin

While it may appear that Fed Chairman Jerome Powell and his deputy James Clarida are at odds over their view of the economy, it must be understood who their comments were aimed at.

Powell completed his six-monthly testimony to Congress yesterday. His remarks are now part of the official record for which he will doubtless be held accountable while Clarida spoke in more general terms having just witnessed another bright piece of economic data being released.

The most recent FOMC minutes portray a monetary policy committee that is fully in sync despite the varying pace of the recovery across the country.

Clarida spoke of the short-term reality of the Pandemic and its effect on the recovery. There is still concern over distribution and more importantly take-up of the vaccine which represents one of the last vestiges of the Trump Administration which downplayed the need for mass inoculation.

He (Clarida) went on to speak of the solid foundations that are being built although he avoided any mention of the spectre of higher unemployment. He also reiterated Powell’s comment that the Fed is using the full range of tools at its disposal to ensure that the recovery is both solid and sustainable once support begins to be removed.

The release of data for new home sales that was released yesterday showed that the availability of cheap money will contribute to house price inflation. This tends to be a precursor of a rise in consumer prices. Fed officials have been strident in their comments regarding inflation.

The FOMC acknowledges the likelihood of prices rising, especially when the restrictions are lifted, but insists that they will be controlled and dealt with according to their severity.

The move to a more flexible inflation target is more than simply a moving of the goalposts since it takes away the need for rigid compliance and has the support of the Treasury.

The comments made in Powell’s testimony soothed asset markets and ended the dollar’s recent rally. The index fell to a low of 89.97, closing at 97.04

Poor distribution and take-up of vaccine causing harm

Christine Lagarde has been closeted with her team recently devising a plan for the Union’s recovery that will be widespread and permanent.

Yesterday she reappeared and gave a speech that was full of optimism but a little short of practical policy decisions.

She pledged to keep policy both flexible and accommodative until the recovery is complete. Her words echoed those of her U.S. counterparts, but they appeared to lack the same conviction.

Given the situation that the region faced going into the Pandemic, it is easy to imagine the economy returning to that level fairly quickly but the systemic issues facing Brussels will take a degree of ingenuity that the EU Commission has so far failed so far to display.

Individual measures continue to be taken by nations to solve their own unique issues.

Even France, which given the Europhile credentials of its President, would normally look to Brussels, is planning to reinstate a series of measures that date back to the seventies.

Emmanuel Macron is looking to reintroduce a system of state backed loans to invigorate the economy and take away the stress of bad loans from bank balance sheets.

This is an admirable attempt to find a solution to a condition that affects several States but is also a testament on the failure of the ECB to find a solution to an issue that is an overhang of the Financial Crisis.

Lagarde spoke yesterday of the need to ensure that fiscal and monetary policy work in tandem to provide favourable conditions to both households and businesses. However, it remains the ability of banks to provide funds, at whatever rate, that is the potential issue since bad loans continue to rise.

Yesterday the euro climbed to 1,2174 but ran into selling pressure as it approached resistance and 1.2180. It fell back only marginally to close at 1.2166.

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.”