3 June 2020: Brexit to drive UK economy

Brexit to drive UK economy

3rd June: Highlights

  • Banks concerned about loan defaults
  • Dollar falls as economic hopes spur risk appetite
  • ECB Members split on the size of PEPP expansion

But banks stuck between a rock and a hard place

Since the Chancellor of the Exchequer announced on March 23rd that the Government was prepared to offer several schemes to help companies, the self employed, and individuals survive the effect of coronavirus, banks have been left with something of a hot potato.

Under pressure to lend as quickly and simply as possible, they have been concerned about the risk they face and have charged significantly higher interest rates to their customers than they would in a normal market.

This has led to disquiet among firms desperate for cash as banks have signalled their concerns that they will be left with significant bad loans (or at least their portion, unguaranteed by Government) should the businesses fail or suffer severe cash flow issues.

There have been several issues with the various schemes and now with businesses facing the start of their requirement to subsidize to, first, pension schemes and then, other contributions, banks are concerned that the rate of business failures will skyrocket.

This is part of the economic reality of the recovery from Covid-19. It means that the small victories that have been seen with the economy most likely bottoming out and infections falling significantly, there is still a long hard road to travel.

Even when the pandemic is under complete control, the Government will still have Brexit to contend with. The EU now appears to be threatening a no-deal conclusion as it calls upon London to make concessions although it remains doubtful that Prime Minister Boris Johnson is in the mood to do so.

All this leads to a mixed picture for the pound as it climbs versus an unpredictable dollar seemingly without a safety net.

Yesterday, it rached 1.2575 versus the dollar and closed at 1.2553. This is also a factor of its recovery versus the euro which appears to be stalling following its own recent rally. Versus the single currency, the pound reached a high of 1.1278, closing at 1.1226.

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Chinese tensions remain on the horizon

The dollar index resumed its correction yesterday, despite continuing domestic tensions, global risk appetite remained strong. Stock markets continue to perform well and commodity prices are rallying.

As in the case of Sterling this goldilocks scenario appears a little superficial as while it may be considered neither too hot or too cold for now, freezing winds are going to blow in and confirm a bleak Q2 for the global economy.

Of course, a large part of the global recession is discounted but there is no way of knowing just how many businesses will fail to reopen, how many businesses will be in a position to take up the slack in employment and how global demand will grow.

While output data which has been seen this week improves so will risk appetite but when it has levelled off at historically low rates, then risk appetite will likely wither on the vine and the dollar will recover.

In the U.S. not only is the battle to contain Covid-919 still raging but the added issues of the continuing racial tensions threaten to boil over at any point with the President threatening to send in troops while the election looms in the background.

The Congressional Budget Office which is a non-Partisan branch that supplies data and estimates to Congress issued a gloomy report yesterday in which it estimated that, given how the U.S. manufacturing base now barely exists, it may take a decade for the U.S. to fully recover from the pandemic. What is true for the U.S. is also probably true for most of the western industrialized nations.

Despite that appraisal and the weakness of output data, the dollar index continued its fall. It reached a low of 97.43 although it rallied a little to close at 97.70

Splits appearing in several areas

Despite market expectations which expect the single currency to start another fall any time, it continues to defy gravity as it reacts to dollar weakness and a rise in global risk appetite.

Despite activity and output data being released, this week’s main event is the ECB meeting which talkies place tomorrow.

Under Mario Draghi the Central Bank, despite its inability to really do any more than prop up the Eurozone economy, while sitting on the sidelines of any major structural discussions was considered a well run and sound institution.

As the Pandemic has hit an economy which was already falling into recession, Christine Lagarde could not have taken over at a more inopportune time. Add to that a new pair of officials at the head of The European Commission and European Council and you are left with a recipe for disaster.

It seems that the multi headed beast has been decapitated not one but three times.

The European recovery fund is still a mystery and rumours are now spreading that there is a growing level of consternation among Central bankers who make up the General Council of the ECB over the size of the liquidity that is being added to the market via QE.

This stems primarily from fears over Bundesbank involvement. Despite the President of the Bundesbank Jens Weidmann saying that there will be no constitutional issue, despite the court finding otherwise, if the Bundesbank is not allowed to take part in ongoing funding, where will the funds come from?

This is why despite the fairly innocuous likely outcome of the meeting tomorrow it could also run into significant difficulties and Ms. Lagardes press conference will be awaited with more than the usual interest.

Yesterday, the euro rose to 1.1196, closing at 1.1172. It now seems that the strong resistance at 1.1020 will serve as equally strong support and it will take a major fall from grace to see the euro trading below 1.10 in the coming days/weeks.

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.”