The Honeymoon Is Over

Barely 3 weeks into the job, and the UK Prime Minister, Boris Johnson, is already facing mounting opposition from Members of Parliament to oust his government. This political pressure comes from the combined forces of nearly all opposition parties as well as members of his own party. Chief amongst their aims is to stop a Hard Brexit, which they believe will damage the UK. However, what the disparate groupings are less united on is who should lead any caretaker government that they would install to replace the current government.

Sterling has gained about 1-cent against the Euro, and by a similar margin against the Greenback and other majors.

While Brexit remains the main focus there have also been other developments in the UK this week. Data showing stronger-than-expected readings for employment, wage growth, CPI inflation and retail sales has been released but all that seems to have had little impact on markets. The consensus remains that the Bank of England is unlikely to raise interest rates given current uncertainties, but slightly above target inflation and the tight labour market also rule out rate cuts for now. The coming week’s limited data schedule is certainly unlikely to have much market impact. However, Tuesday’s August CBI industrial trends survey will provide an interesting insight into manufacturing conditions given ongoing concerns about that sector. Moreover, July public finances (Wed) will provide a further indication of how much room the Government may have to loosen fiscal policy. There are still a couple of weeks before the UK Parliament returns from its summer recess but speculation about likely developments in the autumn as the Brexit date approaches continues to gather pace. Various media reports this week pointed to the possibility of PM Johnson calling an early general election and an attempt by opposition parties to form a temporary coalition if the government was defeated in a no confidence vote. Meanwhile, there is little sign of progress in Brexit negotiations or indeed any sign that talks are underway in earnest. However, some reports suggest that UK PM Johnson will soon meet with key EU leaders including German PM Merkel.

The turmoil in markets has continued over the past week. Equity markets have slid further, while government bond yields posted new lows. US 30-year Treasury yields have fallen below 2% for the first time, while inversions of the US and UK yield curves have been heralded as signalling a strong likelihood of recession. There were brief signs of the situation stabilising in the first half of the week after the US announced that some of the further tariff increases on imports from China planned for September, will now be delayed until December. However, the more positive mood proved short lived as weaker-than-expected China data and confirmation that the German output shrunk in Q2 reinforced the ‘risk off’ mood in markets. Subsequent comments from both US and China sources, which suggested that the two sides were still some way from a trade deal, added to the pessimism while stronger-than-expected US data provided only brief assurance. Growing concerns about the downside risks to economic growth are leading markets to price in increasingly aggressive cuts in interest rates from central banks around the world. That is particularly the case for the US where another decrease at the Fed’s meeting in September is seen as a near certainty and up to a 100 basis points of cuts in all over the next twelve months is seen as likely. That extent of easing is at odds with Fed Chair Powell’s comments following the US central bank’s July interest rate reduction. At that point he suggested further easing was likely but that this was probably a mid-cycle adjustment rather than the start of a long series of cuts. However, since then we have had the further increase in trade tensions and slump in equities, have prompted hopes that the Fed’s upcoming Jackson Hole symposium (starting Friday) will see him turn more ‘dovish’. Jackson Hole is the Fed policymakers’ annual get together with academics and central bankers from other countries to discuss technical issues of monetary policy. This year’s event is titled the Challenges for Monetary Policy. However, Fed Chairs have often used their opening speech to discuss near-term policy issues and that will probably be the case on this occasion. In line with other recent comments from Fed policymakers, Fed Chair Powell is likely to note that he is monitoring recent developments closely and may strongly hint at the possibility of a September rate cut. But he may still disappoint markets by suggesting that a series of rate cuts is still not the most likely outcome. Earlier in the week, the minutes of the July Fed policy meeting will be released, but they are likely to be seen as ‘old news’.

While next week’s data calendar is generally very light the Eurozone August PMIs (Thu) will attract interest. Alongside confirmation this week that German GDP shrunk in Q2, the ZEW survey suggested that both the current situation and future prospects have considerably worsened in August. While that news added to the current pessimistic mood in markets it is recognised that as a survey of financial analysts, the ZEW is a less reliable indicator than the PMIs. In July, the overall level of the PMIs was still signalling sluggish growth rather than outright recession but with manufacturing looking considerably weaker than services. Economists’ forecasts point to only modest further falls in both indicators in August, but following the very weak ZEW, markets may be worried that the message will be more pessimistic. Also on Thursday, the minutes of the July European Central Bank meeting will be scrutinised for any further indications of the exact size and shape of the new monetary stimulus package expected from the ECB in September. Meanwhile, the Italian political situation will command attention. On Tuesday, Prime Minister Conte will address the Senate, when he seems likely to face a vote of no confidence. If he loses, the Italian President will have to choose between trying to form an alternative government or calling a general election. Even if Conte wins the reprieve may only be temporary as he faces another difficult session in the lower house of parliament on Wednesday.

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