25 October 2022: Finally, common sense prevails

Finally, common sense prevails

Morning mid-market rates – The majors

25th October: Highlights

  • Sunak had no real rivals in the end
  • Goldman Sachs urges the Fed to be patient to avoid a recession
  • Downturn worsens – Germany may already be in recession

GBP – UK facing a profound economic challenge

One thing the Conservative Party can learn from the past eight weeks is that their membership is hopelessly out of touch with reality and can no longer be trusted to choose a leader who stands for modern Conservative values.

Liz Truss’s winning margin, which was less than that gained by either Boris Johnson or David Cameron, reflected the changing values of the membership.

It was entirely proper that Sunak should win the leadership unopposed, but now the tough task of restoring unity and confidence within the party begins.

There is a concern that Sunak’s victory will herald a return to the programme of austerity seen following the 2008 monetary crisis, although it is unclear whether the rise in National Insurance contributions reversed by Truss will be reinstated.

It is a sign of the times that Sunak has been chosen on both his reputation and personality rather than any one set of policies.

Opposition Parties have been baying for a General Election in recent days, driven by the view that many mistakenly cast their ballot for party leaders, disregarding the fact that there are local candidates.

The leadership issue can now be put to bed, and the new Prime Minister can get on with the three most pressing tasks he faces: the economy, the repair of the NHS, and the lack of post-Brexit immigration which affects many small businesses.

Rebuilding the confidence of the financial market should be relatively straightforward for the former Chancellor, who built his reputation during the COVID-19 crisis. Gaining the confidence of his Party and the wider electorate may be more difficult given the promises that have been broken over the past three years.

The markets initially welcomed Sunak’s election, although that support could quickly evaporate once the details of the revised tax and benefits packages are announced next week.

The senior members of Sunak’s cabinet will be announced today, with all eyes fixed on who will occupy his former home of 11 Downing Street.

The Pound greeted the result of the election by rising to a high of 1.1409 versus the Dollar, but a lack of momentum saw it fall back to close at 1.1279.

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USD – Another seventy five basis points may not be necessary

As the Fed has now reached, and gone above, what many observers believe is a neutral level of interest rates, the time may have come to slow the rate of increases slightly or call a halt entirely.

The employment market is beginning to lose momentum and the two remaining headline growth reports may show sufficient cooling of the market to presage job losses in the first quarter of 2023.

That alone should cause a fall in headline inflation, which should satisfy Jerome Powell’s lust for inflation to be brought back to the Administration’s target of 2%.

As rising inflation has been created by matters outside the control of the Central Bank, it is unrealistic to believe that they can be cured by tighter monetary policy alone.

Now that neutrality has been achieved, the Central Bank has an opportunity to observe the effect of the tightening that has taken place in monetary policy since the current programme of interest rate increases began last March.

No doubt the Dollar will take a hit for the perceived dovishness of the FOMC, but if Powell is sufficiently assertive, assuring the market that the Fed’s work has paused rather than been completed, it should relieve the pressure on him and allow the Central Bank to become less predictable in its actions.

The reality of the Fed’s current policy is that rates will likely be hiked by seventy-five basis points next week and a further fifty points in December.

Several banks are beginning to call for restraint from the FOMC given the signs of cooling in the employment market, but it is unlikely that their calls for patience will be heeded.

Property cost data will be released later today – another market showing signs of a slowdown following the recent tightening of interest rates,

The house price index is expected to fall from an annual rate of 16.1% last month to 14.4% in October, while house prices are expected to have fallen month on month by 0.6%.

The Dollar is less affected by the likelihood of a further tightening of interest rates than it has been in recent months. Yesterday, it gained a little ground, but its highs are becoming lower, representing a loss of confidence. It reached a high of 112.54 and closed at 111.98.

EUR – Rates need to reach neutral as soon as possible

The ECB is still under significant pressure to tighten its monetary policy. Still, some are slowly beginning to realise that inflation cannot be driven lower by tighter monetary policy alone, and there are natural phenomena which also contribute.

Yesterday’s data showed that the German economy is slowing to such an extent that recession is virtually inevitable.

The composite index of manufacturing and services output fell to a low of 44.1 from 45.7 last month, while the index for the entire Eurozone also fell, to 47.1 from 48.1.

Manufacturing output alone is slowing at an alarming rate, and should it continue, it may cause Q4 GDP to slump considerably.

The IFO Institute, a highly regarded Munich-based research establishment, will release its findings on the business climate today, as well as current and future expectations for the German economy. All three measures are expected to see significant falls.

The ECB Governing Council gathers in Frankfurt today for the start of yet another crucial monetary policy meeting, which will last for two days beginning tomorrow.

There is little doubt that interest rates will increase, probably by seventy-five basis points. Rates will also be raised at the next meeting, as it is now considered vital that official rates return to a neutral level as soon as possible.

Yesterday’s data was the fourth consecutive month of lower readings, indicating a full-blown recession.

Homeowners across the Eurozone will eagerly observe the events in Frankfurt as they fear their mortgage rates are set to rise again, adding to the cost-of-living crisis.

The expectation of tightening monetary policy is one of the few factors currently supporting the single currency. Yesterday, it climbed to a high of 0.9899 and closed at 0.9874.

Have a great day!

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.