Despite Donald Trump having been inaugurated as the 45th President of the United States only 28 days ago, saying that it has been an event-packed month is the under-statement of the decade.
However, as Randy Bachman sang in his number-one hit in 1974 – incidentally the year President Richard Nixon resigned following the Watergate scandal – “You Ain’t Seen Nothing Yet”.
The media and financial markets have tried to make sense of a number of key themes in the past twelve months, including:
The relative stability in the Dollar, S&P 500 and US yields is broadly in line with my view that analysts and markets had got ahead of themselves with respect to the path of the US economy and financial markets.
Moreover, Chinese policy makers’ willingness and ability to use central bank FX reserves to support the Renminbi tallies with my expectation that “near-term, the PBoC may continue to see some value in a broadly stable Renminbi.”
Currency, equity and bond markets may also be suffering from “political-fatigue”, with Donald Trump’s “policy-by-tweets” exhibiting diminishing returns.
Expectations that Trump will have to deliver a more cohesive set of policy priorities will likely rise exponentially after his inauguration as President today. If he is unwilling or unable, markets’ good-will may flounder and the Dollar and US equities may correct lower.
In the UK, Theresa May’s speech was an important milestone in the UK’s already tortuous path towards a world outside the EU. But there are still many legal, political and economic hurdles the government must clear, including a number of parliamentary votes.
Given the uncertain path which British executive and legislative bodies will take to reach a difficult-to-predict outcome at a still unidentifiable point in the future, fluctuations in Sterling will likely remain common-place.
I see the risk tilted towards Sterling weakness due to the British government’s acute challenge of negotiating favourable trade deals with EU and non-EU countries and the UK economy’s reliance on faltering household consumption growth.
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British Prime Minister Theresa May will make a speech on Tuesday 17th January in which she will set out in greater details her plans for the UK’s exit from the EU.
There have been few signs that she is willing to tone down her mantra of the UK regaining control over immigration in exchange for a bespoke trading deal with the EU which may exclude access to the Single Market.
If Theresa May sticks to her guns next week I would expect Sterling to weaken further.
A sell-off in Sterling could be partly curbed if Prime Minister May agrees more explicitly to a transition agreement whereby the UK still retains some of the benefits of EU membership even after the UK has officially left the EU.
If MPs perceive Theresa May’s speech as insufficiently detailed or it is not backed up with a detailed and formal government white paper, parliament may decide to delay or even scupper the process by which Article 50 is triggered.
This would at the margin increase the perceived odds of the UK remaining in the EU and may provide some relief for Sterling.
However, I would view this as only a temporary reprieve as ultimately the government has a popular mandate for the UK to leave the EU.
The apparent resilience of British economic growth since the June referendum has given weight to the arguments that the economy can easily weather the UK’s exit from the EU and that the British government is in a strong negotiating position.
However, the risk now is perhaps that too much confidence is being placed in the British economy’s ability to weather a number of possible forthcoming challenges. Read more
The rise in bond yields in developed economies in the past 6 weeks remains one of the over-riding themes as we head into the last seven days of the US presidential campaigns.
Markets are now fretting about the implications for global growth and asset valuations and ultimately whether elevated global risk appetite will correct more forcefully.
Higher international commodity prices, a pick-up in global GDP growth in Q3 and early Q4 and easing deflation fears suggest that interest rate policies in developed economies may have reached an important inflexion point – in line with the view I expressed six weeks ago.
Developed central banks may refrain from loosening monetary policy further near-term, with the exception of the RBNZ and possibly ECB. At the very least, policy-makers will tweak a discourse which has largely focused on doing “whatever it takes”.
Recent US data have paved the paved the way for a 14th December Fed hike, conditional on Democrat candidate Hilary Clinton wining the 8th November US presidential elections.
But with the exception of the Fed and possibly a handful of EM central banks, rate hikes are a story for the latter part of 2017 (perhaps) while further rate cuts remain on the cards in Brazil, Russia, Indonesia and India.
Higher global yields and still uncertain US election outcome are taming global equities and volatility has spiked but EM currencies have still managed to eek out modest gains.
Assuming Hilary Clinton wins next week, I would expect the initial reaction to be a rally in global equities, EM currencies and Dollar and an underperformance of safe-haven assets.
But I would also expect market pricing for a December Fed hike to rise a little further, which could in turn eventually curtail any rally in global equities and EM currencies.
In this scenario, the Dollar would likely end the year stronger, as per my January forecast of a third consecutive year of albeit more modest Dollar gains.
Whether global risk appetite avoids its early 2016 fate will depend on the interconnected factors of underlying macro data and the Fed’s credibility. In any case, market volatility could spike in the run-up to March 2017.
The self-reinforcing sell-off in Sterling and UK bonds has only very recently abated, with markets seemingly taken some comfort from a number of factors including the only modest slowdown in UK GDP growth to 0.5% qoq in Q3.
But optimism over UK GDP data is not warranted as growth has become more unbalanced and slowed in August-September despite a significant easing in UK monetary policy. Read more
Sterling’s collapse overnight has eclipsed somewhat tepid US labour market data.
The net result is that the Sterling NEER has weakened a further 2% since yesterday and is now down about 20% since November 2015.
While trading desks will have a far better grasp of how risk management systems and liquidity contributed to sterling’s drop, recent political decisions and UK data clearly helped set the scene and will leave the currency vulnerable going forward.
Theresa May’s government and EU leaders have in recent weeks successively dismantled the raft of hopeful predictions which had helped Sterling stabilise over the summer.
Moreover, there is growing evidence that a more competitive Sterling has not translated into materially stronger UK industrial output or exports, with the UK’s trade deficit in goods and services widening in recent months
I would reiterate my view, expressed in early July, that the uncertainty associated with the UK’s possible exit from the EU will likely continue to weigh on the UK economy and currency.
This week’s fall in sterling, if anything, has reinforced my view that the Bank of England will maintain a dovish rhetoric but for now refrain from cutting its policy rate to zero or expanding its current QE program.
Moreover I would not expect the BoE to intervene in the FX market to support sterling at this stage. Read more
Recent comments from the Fed, ECB and BoJ have rattled financial markets after a summer of relatively low volatility.
The correction in financial markets has so far been relatively modest, particularly for equities and the dollar. But the questions remain where global monetary policy goes from here, the implications for asset valuations and ultimately whether elevated global risk appetite will correct more forcefully.
My core view is that eight years of ultra-low (and in some cases negative) central bank policy rates and expansive bond-buying programs have helped stabilise global growth and inflation, albeit at low levels.
At the same time, the costs of ultra-loose monetary policy, including asset price bubbles, distortions in bond markets, pressure on the banking sector and even rising inequality, may be starting to outweigh the benefits.
Therefore, major central banks, with the exception of the BoJ, may refrain from loosening monetary policy further near-term.
I would certainly expect central bank policy rate cuts to become increasingly less frequent than in the past and the ECB and BoE to keep the modalities of their current QE programs broadly unchanged for now.
At the very least, the world’s most influential central bankers may going forward tweak a discourse which has in recent years largely focused on doing “whatever it takes”.
To be clear, the risk near-term remains biased towards more central bank monetary policy easing. Bar the Fed and possibly a handful of EM central banks still fighting weak currencies and high inflation, no major central bank is likely to hike policy rates or tighten monetary policy this year, in my view. That’s a story for 2017, at the earliest.
But if we have indeed reached an inflection point in global central bank monetary policy, if anything financial markets will become more sensitive to any downturns in still tepid global growth and inflation and to the negative side-effects of loose monetary policy.
In this context higher volatility is likely to prevail and global risk appetite may struggle to forcefully regain traction for now. Read more
We may well never know the true extent of the impact of the EU referendum outcome on the British economy, markets and ultimately standards of living. This may not be the most satisfying conclusion, but this uncertainty is one which policy-makers will have to grapple with.
As to the bigger question of whether the UK is better off today or will be better off in years to come when one takes into account not only the impact on the economy but also broader, less tangible issues such as sovereignty, the answer is and will likely remain even more subjective.
In any case, available data paint a patchy picture of the UK economy post-referendum. Construction and services have been harder hit than manufacturing. Retail sales were strong in July thanks in part to a robust labour market and plentiful lending. While this defies the collapse in consumer confidence temporary factors may also have been at play.
The residential property market at a national level has been softer but resilient post referendum. Mortgage lending remains depressed but government policies are for now more likely to blame. The commercial property market has been harder hit.
Sterling’s 10% collapse since the referendum, following a 10% depreciation between November and June, is seemingly supporting economic growth and demand for UK assets even if history suggests that it is no panacea. Its inflationary impact has so far been very modest but the risk is a squeeze on profit margins and real wages.
At the same time sterling’s collapse has tangibly eroded the UK’s net wealth, at least when expressed in foreign-currency terms – a fact largely ignored by policy-makers and the media.
I would expect the BoE to continue favouring monetary and credit policies which explicitly help spur lending, spending and investment and, implicitly at least, help cap sterling. While this may not translate into another policy rate cut or round of QE near-term, the BoE is likely to keep this option firmly on the table if the UK economy fails to return to trend in the next six months.
The US Federal Reserve and markets have been engaged in a bruising duel for the past six months. Round 6 should have been an easy one for the Fed given reasonably well behaved equity and FX markets, surging energy prices and signs that global GDP growth was stabilising.
But softer US employment data for May have put the Fed on the ropes, with markets having now all but priced out a hike next week and only pricing in a 24% probability of a hike on 27th July.
The Fed is not down, however, thanks to decent earnings, income and spending, a pick-up in most inflation measures in April and a robust housing market, which all point to a rebound in GDP growth in Q2.
In the labour market, an increasingly high percentage of those who want a job are finding one and the steady share of full-time employees points to decent hourly earnings growth in months ahead. There is still slack but arguably less than in December when the Fed hiked.
The Fed will be hoping that the next data set, particularly for the labour market, manufacturing and inflation, will go its way so that it can finally deliver a second-hike in a decade at its July meeting.
This is still my core scenario, although if labour data for June disappoint the Fed may well turn to its 21st September meeting as its next possible trigger point.
A July or September hike would leave the Fed with another few rounds to hike its policy rate by another 25bps, in line with Fed members’ current average forecast of two hikes in 2016. The Fed will want to show markets that it will not be swayed by soft data punches or temporary market developments and is still in control, but without flooring markets. Read more
The Federal Reserve has 23 more days worth of data and market developments to analyse before its policy meeting.
China’s official and (unofficial) Caixin manufacturing data for May will be released tomorrow and Friday before the usual deluge of monthly economic indicators. Markets tend to give weight to the early release of PMI data in the world’s second largest economy and the question is whether this is justified.
Looking at data for the past decade, there was a good correlation up till about 2012 between China’s official manufacturing PMI and exports, imports, industrial output, retail sales and GDP, with the added advantage of the PMI leading by a couple of months. However, since then these correlations on the surface appear to have broken down, even if we use the sub-components of headline PMI.
The main issue is seemingly one of calibration. Since 2012, the official manufacturing PMI has only fallen marginally in a narrow 49.0-51.7 range while monthly economic indicators have weakened considerably. If we shorten the time scale, the PMI’s correlations with monthly data again look reasonable.
Markets need to take into account this increased sensitivity of the PMI data, as small moves may ultimately be associated with significant changes in underlying economic activity.
Even so, the official manufacturing PMI has seemingly over-estimated China’s economic strength in recent months. An alternative view point is that monthly economic indicators are about to rebound quite sharply.
The unofficial Caxin manufacturing PMI data – which have been more volatile than the official measure – and the official non-manufacturing PMI have even over longer time-frames been somewhat better correlated with monthly economic indicators. They too point to a rebound in economic activity in coming months.
Please see Appendix for complete set of correlation charts.