Johnson’s message to Brussels; Renegotiate, or its no-deal

The pound has shed 2.4% of its value versus the dollar since Boris Johnson became Prime Minister. Investors concerned about the effect on the UK economy of a no-deal Brexit are either shying away completely from UK assets are hedging their currency risk. Either way, the pound is unlikely to recover while the current uncertainty exists.

The Irish Prime Minister Leo Varadkar continued the rhetoric of the EU yesterday commenting that the existing deal is the only one available and that Brussels will not re-open negotiations.

The feeling among traders is not that no-deal is necessarily a bad thing for the UK, it is simply concerned over the uncertainty such a decision will create.

The pound made a low of 1.2119 versus the dollar yesterday, the lowest level since March last year. It was trading at around 1.3200 just two months ago.

It is hard to imagine that the Brussels position will remain unchanged as the economic fallout will also affect the entire EU, which can barely afford any further economic shocks. So far, Johnson has sidelined Parliament other than to inform MPs that Brexit will happen on 31st October, “come what may”.

Having surrounded himself with a team, with the same attitude to Brexit as his and confident of the support of the Northern Irish MPs, Johnson clearly feels that he can carry Parliament despite his wafer-thin majority.

The pound also continued its fall versus the euro yesterday, reaching a low of 1.0880 and closing at 1.0893.

The pound’s precipitous fall will have an immediate effect on inflation and the Bank of England could soon be faced with a dilemma over short-term interest rates although it is certain that any yield differential could not save the pound at the current time.

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Dollar marks time as it awaits the Fed

The Federal Open Market Committee (FOMC) will later today announce the first cut in interest rates in the U.S. in eleven years. It would be a major surprise were they to decide against a hike given both the advance guidance and market perception. It has been made clear by Fed Chair Jerome Powell that market sentiment will have no bearing on either the discussions or the outcome, but it is highly unlikely that analysts could have got the call on rates so wrong.

The burning question, as it always is in such situations, is “what happens next”. Powell has it within his grasp to move sentiment in either direction. The data since the last meeting has been generally supportive, predicting growth in the economy. Q2 GDP was a “sign of the times”. In the current globalized world economy, it is hard to grow while the rest of the world begins to suffer so an economy which expanded by 2.1% in the latest quarter is performing well.

The market is aware of this fact and there have been no comparisons between Q1 and Q2 which would be like comparing apples and oranges in a global context.

As trade talks between Washington and Beijing rumble on, both President Trump and his Chinese counterpart Xi Jinping, have attempted to manage expectations lower. They have both said that the talks continue but with a less significant outcome expected.

Traders are confident that they have positioned themselves in accordance with their expectations for the FOMC meeting and the dollar index was muted yesterday, reacting to activity elsewhere.

It rose to a high of 98.21 but closed just one pip higher on the day at 98.07.

Two-tier Eurozone developing

Historically, before the creation of the Eurozone, the major European economies were divided very clearly by their performance but more importantly their methodology in dealing with growth and debt.

Germany, Belgium and the Netherlands, for example, were very conscious of inflation and monetary policy was geared to that. Italy, Spain and Greece were at the opposite end of the scale, known for boom/bust economies with high interest rates and high inflation. That rather simplistic view is starting to develop again as budget deficits become the dividing line.

40% of the Eurozone have balanced budgets and have growing surpluses while the rest are suffering with their level of borrowing which exceeds Brussels 60% of GDP ceiling. Greece is the current worst offender with borrowing at 182% of GDP, with Italy about to breach 140%.

Despite high employment, Rome and Athens remain under constant pressure, as do several other nations, to cut public spending. This is a major concern as the populations of those countries see their economies being both criticized and ever more controlled by Brussels. This has led to an upswing in populism in these States and shows no sign of abating.

“Easy money” as the ECB tries to add accommodation to the entire economy has become life support for those heavily indebted nations as they fund existing debt but show little sign of paying down liabilities.

France had embarked on a quest to “put its house in order” lowering its budget deficit from a peak of 7.2% to 2.8%, comfortably below Brussels 3% ceiling. President Macron wanted to go further, showing his admiration for Frankfurt, only to run into considerable social unrest which spawned the “Gilets Jaunes” protests and he was forced to accede to their demands. The French budget deficit has ballooned to 3.6% now as tax increases particularly on fuel have been removed.

The ECB is left exposed trying to stimulate growth which is the only long-term answer to debt issues. However, what is needed are fiscal changes, unifying the entire region under one tax and social welfare regime. This would provide more flexibility and allow for economic stimulation as seen last year in the U.S.

Yesterday, the single currency drifted versus a directionless dollar, reaching a high of 1.1161 and closing at 1.1157.