29 July 2022: Housing market set to fall

Housing market set to fall

Morning mid-market rates – The majors
GBP > USD
=1.2235
GBP > EUR
=1.1943
EUR > USD
=1.0248
GBP > AUD
=1.7442
GBP > ILS
=4.1406
GBP > CAD
=1.5664

29th July: Highlights

  • Bank of England set to follow FOMC lead
  • Recession arrives
  • Italy’s struggles reverberate around the Eurozone

GBP – Mortgage rates to soar as bank continues to hike

One of the cornerstones of the British economy is set to suffer a significant downturn. The housing market has so far been fairly immune to rising interest rates, but that is about to change as the effect of rising interest rates as well as the cost-of-living crisis combine to make homeowners think again about selling up and moving on.

Lloyds Bank, Britain’s largest mortgage lender, has reported that its mortgage book rose by just 1% in the three months to June. The Bank’s Chief Executive reported that if it hadn’t been for clients rushing to lock-in lower rates by mortgaging existing properties, activity would have fallen significantly.

Despite there having been no major data releases this week, sentiment around the UK economy and its ability to avoid a recession. With the Bank of England meeting next week to decide on a further hike in interest rates, Andrew Bailey has signalled that a further fifty-point increase is likely.

Although it began to hike rates last December, the Central bank has fallen behind the U.S. where the FOMC has adopted a far more aggressive set of policies.

The drip feed of monthly hikes of twenty-five basis points were intended to tighten monetary policy while also allowing the economy to maintain an, albeit lower, level of activity.

Rising inflation has seen those hikes swallowed up and have, so far, had zero effect on inflation. It may not now be the time for more aggressive tightening, as recession beckons.

The pound continues to see a seasonally unusual level of volatility as the market continues to digest the comments made by FOMC Chairman Jerome Powell this week.

Overall, the pound has recovered well over the past two weeks, although that recovery has had little to do with comments emanating from the Bank, nor any improvement in sentiment. It rose to a high of 1.2191 yesterday, but was unable to sustain sufficient momentum to seriously challenge resistance around the 1.22 level and drifted back to close at 1.2177.

While ranges remain quite narrow, volatility remains high, and this is unlikely to change next week as traders anticipate what the Bank’s Governor will say in his remarks following the MPC’s rate decision.

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USD – Demand strong, rates rising, but output suffers

It is odd to see the accepted circumstances under which an economy is considered to be in recession questioned. The U.S. economy contracted in Q2, but by a lesser amount than in Q1.

Nevertheless, two consecutive quarters of contraction signal a recession. Not that a recession remains a possibility, but it has already arrived.

In his remarks following the decision of the FOMC to hike by another seventy-five basis points a couple of days ago, there is no doubt that Jerome Powell will have had advance warning of yesterday’s data but chose to either ignore it, or the generally accepted economic marker.

It remains to be seen if the Fed will announce its own methodology in the coming days or weeks, since it is choosing to ignore the current one.

The Federal Reserve has chosen to ignore the fact that technically, the economy is in recession, most likely because for now it is not going to either acknowledge the fact or do anything about it.

With interest rates now at the generally accepted neutral level, there will be a natural break in the Bank’s tightening of monetary policy.

Following Last Wednesday’s FOMC meeting, it is difficult to believe that there are only three meetings left this year.

One major European Bank released guidance to its customers yesterday signalling its expectation that rates will rise another 100 points before year-end, bringing the Fed funds target to between 3.25% and 3.50%.

These are indeed strange times, with not only the recession but stagflation being ignored. While there is no textbook definition of stagflation, if it looks like a duck, swims like a duck, and quacks like a duck, then it’s a duck, and no amount of denial will change that.

No central banker in living memory has had to deal with the set of circumstances that are currently facing the Fed Chairman, and it is therefore no surprise that the level of advice he has been receiving has dried up faster than Russian gas supply.

Traders have now apparently decided that the level of interest rate hikes will also decline in the coming months, even if the next three meetings yield another one hundred basis points.

Yesterday, the dollar index continued its recent decline, falling to a low of 106.05. It has now broken support that was set at around 106.20 since it closed at 106.16. It remains to be seen if there is sufficient momentum building to see more significant support around 105.80 tested.

EUR – Energy is the catalyst, but it all looks bad

While all European eyes have turned to look east as Russia ceases supply of gas to Europe, it is not just the Kremlin’s vengeance that has brought the Eurozone economy to the parlous state it now finds itself in.

The roots of this problem are to be found way back in the original design of one size fits all. Two past crises have not seen the ECB, or indeed the European Commission, learn the obvious lesson.

While it solved the ambition of Germany to be the undisputed financial leader of the Union, what it did to primarily Italy, but also other weaker Eurozone in order to make them comply with budgetary rules led to a significant crisis in those nations and this was exacerbated during the 2012 crisis which left those nations too weak respond.

Most recently, the determination of Angela Merkel to ensure that Germany was at the forefront of the entire Union by insisting it appoint the clearly incapable, Ursula von der Leyen as European Commission President had the knock-on effect of Jens Weidmann being sacrificed when he was the perfect man to replace Marion Draghi as ECB President.

The appointment of the more politically astute Christine Lagarde has led the Central Bank into being all things to all men, which led the slowing economy to be given longer than necessary to recover from the Pandemic, a feat that was impossible to achieve.

Now recession has arrived in all but name and rising inflation will lead the Union to question its very existence, since German hegemony has been blunted by rising inflation. The hawks have taken over the Frankfurt Head Office of the ECB.

Further rate hikes will be seen, and this will push the economy into a deeper recession, and that is without what is happening in Ukraine and the Russian instinct for revenge.

The only thing supporting the single currency currently is the market’s perception that Jerome Powell is going to turn more dovish in the coming months as inflation begins to self-regulate and the economy contracts further.

The euro fell to a low of 1.0114 yesterday, testing the bottom of its recent range, but bounced back, driven by a weaker dollar to close at 1.0197.

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.”