9 August 2022: Bailey asleep at the wheel

Bailey asleep at the wheel

Morning mid-market rates – The majors

9th August: Highlights

  • Political vacuum threatens any chance of recovery in the medium-term
  • Business investment curbed as FOMC continues to fight inflation
  • ECB pumping billions into weaker economies

GBP – No ifs or buts, inflation still the target

The two contenders to be leader of the Conservative Party and become the next Prime Minister are at odds over how they will act to solve the continuing rise in inflation and the downturn in the economy.

The most important question that needs to be asked is why is Truss so hell-bent on providing support for individuals through tax cuts, while Sunak is determined to introduce measures to reduce inflation.

The most obvious answer is that both are using policies that they may not genuinely believe in to garner votes from Conservative party members.

In the case of Liz Truss, she cannot possibly not have been advised by her teams that cutting taxes at this time will fuel inflation, while Sunak is doubtless aware that rising inflation, forecast by Bank of England Governor, Andrew Bailey, to reach 13.5% in the Autumn, is due to several factors that out of his hands.

Rather than promising measures that will improve the outlook for people, the focus should be on attempting to nullify the negative effects.

The forecast increase in the energy cap that will take place in the Autumn is clearly the most significant factor in the rise in inflation, as well as causing a significant blow to family budgets.

Neither candidate has discussed measures to use windfall taxes on energy companies to offset the rise in the cap. That would seem to be the most efficient action, although it is neither immediate nor headline grabbing.

Opposition parties, led by former Prime Minister Gordon Brown, are calling for the early return of Parliament from its summer recess to discuss the implementation of an emergency budget.

As with the leadership contest, it is questionable what can be achieved. While no one would suggest simply the Government simply sat on its hands, weathering the storm and nullifying its effect with temporary measures would appear to be the most effective path.

If continual hikes in interest rates are having little or no effect on inflation, why continue, particularly when the additional cost of borrowing is hurting households.

Former MPC member Danny Blanchflower commented recently that he would be voting for a cut in interest rates were he still to be a member. That is a radical approach but also one that should have been considered.

In its considerations, the MPC appears to be having to use compromise to placate both dovish and hawkish members. which defeats purpose.

The markets appear confused by current Central Bank policy, with the pound seeing significantly reduced volume of trade but still high volatility. Yesterday, it traded up to a high of 1.2137, but ran out of steam and drifted lower to close at 1.2081 just a few pips higher on the day.

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USD – Very few chances to lower inflation remain

As has been said before, every recession is different, and the current technical recession the U.S. economy is suffering from may be little more than the effect of the seismic events of the past two years on the U.S. economy.

President Biden was elected at the worst possible time for his Party. As a Democrat he will feel bound to improve the lot of the ‘common man’ since that is what marks the Democrats and Republicans apart.

Biden’s predecessor, Donald Trump, wouldn’t have fed inflation with direct support, but would have used indirect methods by ensuring that big business was both profitable and supported.

In the end, it is likely that either way, we would have ended up where we are today.

A great deal of the criticism Biden is receiving from his own party currently is driven by the fears that they will lose their seats in the midterm elections that will take place in November.

A further criticism of the Biden administration has been its perceived weakness in foreign policy. He has allowed Russia to steal a march on him in Europe by both its direct invasion of Ukraine and its indirect measures that have nullified any possible response from the European Union.

Globalisation has to work both ways if it is to be successful, even if it is questionable as an overall concept.

While China and the U.S. were falling into a relationship which, despite mutual mistrust, benefitted both, Russia was using its huge reserves of energy to ensnare Europe.

Since the fall of the Berlin Wall and the rise of China, Washington has believed that the latter with its own brand of imperialism ensures supplies of raw materials are readily available in exchange for financial support for huge capital projects in producing countries.

Last week’s release of employment data for July may have been something of a red-herring for the economy, since the definition of new jobs is open to question.

When taking the fact that the four-week average for jobless claims is currently around 250k, that equates to roughly a million new claims a month. When put against the half a million new jobs created, it shows that the employment market isn’t as hot as analysts believe.

Will the FOMC continue to hike rates even if it destroys any hope of a soft landing? The answer is probably yes, mainly due to the fact that it won’t be called a recession, the term now will be “cyclical contraction” or something similar.

The dollar index remains at the lower end of its recent range. Yesterday it traded down to 106.22, closing at 106.40.

EUR – Continued support drove inflation to its current level

When it was first created, the ECB was formed in the image of the German Bundesbank. It was expected to be tough on inflation and adhere closely to the targets it had been given.

However, with no fiscal union driving taxation and social expenditure, the Bank was left exposed and was expected to provide not just disciplined management of monetary policy but also support for weaker heavily indebted EU members.

That has led to two significant crises that have only been weathered by huge cash injections, and the Union is facing possibly its most significant threat as inflation remains high and rising and the economy struggles with the dual effects of the war in Ukraine and a major energy shortage which can only get worse.

Stocks of gas are unseasonably low in Europe, and the tickle of supply coming from Russia is not allowing them to be replenished before winter demand begins.

There is already talk in Germany of having to prioritise certain industries in order to ensure supply to the public. This will have a knock-on effect for the economy, which is already facing recession.

Stagflation has connotations for Germany that remind it of how its economy was destroyed following WWII.

Part of the reasoning behind the formation of the various alliances that have become the European Union was to ensure that such a calamity couldn’t happen again, but in using wealth to try to dominate its neighbours, Germany has allowed itself to become sucked into the maelstrom.

Now with inflation rising and the economy unquestionably falling into recession, Germany finds itself weakening, perhaps at an even faster rate than its heavily indebted partners.

It is becoming clear that the dominant statesmen of the recent past like Kohl, Schroeder and Mitterrand haven’t been replaced, and the weakness was exacerbated by Merkel’s determination to appease.

Now, Brussels is foundering, and it may be time for either and an end to the experiment of at least a radical overhaul. Unfortunately, there is not even a sufficiently strong politician to oversee this, primarily due to the fact that most national leaders are embroiled in their own domestic dilemmas.

The euro continues to attract selling on any perceived strength. Yesterday, it rose to a high of 1.0221 but sell orders are being lowered to capture any false rally, and it fell back to close at 1.0196.

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.”