29 December 2023: The economy contracted in Q3


  • The UK economy is likely already in recession
  • The Fed and the market disagree about the timing of rate cuts
  • Euro sets a five-month high despite growth fears
GBP – Market Commentary

Q4 data to confirm a recession

The Government is going to face an unpalatable truth when the data for the fourth Quarter GDP is published in a few weeks.

The unwelcome news that the economy is in recession is unlikely to spur Rishi Sunak and his Cabinet to call a General Election in the first half of the New Year, although political commentators see early May as the first opportunity for an election to be held.

The date of the budget was announced yesterday. This will be the final opportunity for Chancellor, Jeremy Hunt, to persuade the electorate to “buy in” to his economic vision.

The budget will be delivered on March 5th and is expected to deliver tax cuts and increases in public spending that are needed to provide any prospect of the Conservative Party continuing its, by then, fourteen-year time in power.

The atmosphere across the whole of the United Kingdom is pointing to a change of Government being needed to refresh attitudes and give a necessary boost to the economy to allow it to resume growth.

Although the Election appears to be the Labour Party’s to lose, it will need to supply positive news about its plans to supply sufficient funding to promote a significant fall in NHS waiting lists and revamp the country’s failing transport system.

It is still unlikely that Sir Keir Starmer will introduce any plans to re-nationalize privatized utility companies, and certainly not within his first term in office.

The country’s likely first-ever female Chancellor is highly regarded by many in the financial market, not least by the former Bank of England Governor, Mark Carney.

Carney has endorsed Rachel Reeves, who collaborated with him at the Bank of England early in her career.

The right-wing press will begin the New Year by “talking up” the prospects for the medium to long-term prospects for the economy, which it is likely to promote as “among the strongest in Europe”.

The revision of GDP for the period between July and September from flat to a 0.3% contraction was unexpected to the market. Although the revision was relatively minor, the country will take a significant amount of convincing that the Government has the money to drive a significant change in the country’s fortunes to avoid the recession which will continue for the first half of 2024.

The Bank of England will face not only renewed calls from the market to begin cutting interest rates in the coming months but also an endorsement from the current Chancellor for rates to be lowered.

The market’s expectation of the beginning of rate cuts will hit the pound, which had been supported by recent hawkish comments from the current Governor of the Bank of England, Andrew Bailey, but is expected to weaken over the first quarter of the New Year.

As the market returned following the Christmas holiday yesterday, Sterling gained some strength from renewed expectations that the U.S. will also see lower interest rates over a similar period.

The pound rose to its highest level since August earlier this week, reaching a high of 1.2802. Yesterday, it closed at 1.2732 against the dollar, while against the euro, it continued to see weakness, falling to a low of 1.1495 before closing at 1.1506.

USD – Market Commentary

Recession fears about later in the year growing again

The market’s belief in a soft landing for the U.S. economy is expected to be bolstered by the final employment report of the year, which is due for publication on January 5th.

It seems that for almost the entire year, the market has been considering a significant fall in the creation of new jobs but has been continually surprised by the ability of the economy to continue to show significant strength despite rates having risen to a high of 5.5% over the same period.

A year ago, the Fed Funds rates stood at 4.50% and, even then, there was speculation that the FOMC would pause its cycle of rates which the market believed was in danger of driving the economy into recession.

Now, a year later, and a further one hundred points of rate increases, the economy faces the “goldilocks scenario of continuing falling inflation and rising job creation.

Such a situation which was considered as impossible by all but the most bullish of commentators, will see the Dow Jones Index end the year, close to a record high.

The Market is not heeding the comments made recently by members of the FOMC, including its Chair, Jerome Powell, that interest rates will need to remain at their current level for a substantial time to see inflation finally defeated.

The FOMC feels that a period of observation is necessary, although it does not dispute that interest rates will, in all probability, be lower by the end of June than they are now.

Market expectations currently see the first cut taking place by March, although only the most pessimistic observers see this as a response to a major slowdown in the rate of growth.

Third-quarter GDP was indeed revised back to 4.9% from its fleeting rise above 5%, last week, but that is part of the legacy effect of rate hikes, which the Fed again left on hold at its most recent meeting.

Those traders prepared to deal in typically thin holiday-affected markets this week decided that they should either cut long dollar positions or take advantage of the fleeting weakness of the Greenback, to make a little profit.

The dollar index fell to a low of 100.83 earlier in the week. Yesterday, it rallied to a high of 101.29, closing at 101.24.

EUR – Market Commentary

Higher for longer to remain the mantra

The long-held hawkish attitude of the ECB’s Governing Council may have been tempered a little recently given the probability that the economy has entered recession, but “higher for longer” is still the mantra of Christine Lagarde and her colleagues.

They may well lament the fact that they were not sufficiently hawkish last spring to continue to increase rates by larger increments than were eventually agreed.

This has led to the necessity for rates to remain at their current levels for a longer period than the market expects, but the ECB has a growing reputation for “overshooting”.

This was seen when there was a seemingly interminable delay in the beginning of rate hikes as the Central Bank delayed, wishing to make sure that its support for weaker economies had been sufficient.

Now, those same economies and some of the more “middle-of-the-road” nations are beginning to suffer. France, which is considered neither particularly weak nor strong comparatively, is beginning to suffer and is likely to already be in recession.

The introduction by Germany of “French style” economic policies, including massive subsidies, possibly outside the rules of the European Union, and protectionist, buy European clauses, has seen Europe’s strongest economy succumb to the overall slowdown.

Market observers and practitioners now see that the ECB will likely be the first G7 Central Bank to begin rate cuts as better than 50/50. However, they are ignoring the ECB’s determination to see inflation finally conquered before that happens.

It must be said that the common currency has seen an uncharacteristic level of support over the holiday season.

Yesterday, It lost momentum despite the thin market conditions. It fell to a low of 1.1055 and closed at 1.1065.

Have a great day!

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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.