A Risky Farewell
Today is a historic day politically. That much is apparent. What may be less obvious is the day's historic implications on the economy, and - by extension - the British Pound. In the last 3½ years, politics has had a disproportionate effect on the exchange rate but the anchoring of the economy the EU has had a stabilising effect, to some degree, which will, from today, become absent.
Our view, for the next 11 months, is that positive economic data will have a relatively smaller effect on the exchange rate than negative data of the same magnitude. Domestic politics will take a back seat while Trade deal politics dominates. News of a trade deal - any trade deal - with the USA and/or the EU will be well-received by the market. For the UK economy and Sterling, we see the long term being characterised by a trajectory that is flat-to-downward for both; and by erratic volatility for the latter. And depending on the nature of the trade deal agreed, within 18 months from today, the UK will face its moment of truth.
BANK OF ENGLAND STAYS IN WAIT-AND-SEE MODE In other news, the Bank of England left interest rates on hold with the Monetary Policy Committee voting 7 to 2 in favour of unchanged policy (the same split as the previous two updates). BoE Governor Carney cited signs of a bounce in postelection economic activity as justification for staying on hold. As markets had seen the decision as a close call, sterling appreciated modestly on the news. The next BoE update will be after the 11th March Budget, which is expected to confirm a more expansionary tilt to fiscal policy. In the meantime, the focus will be on whether upcoming data corroborates the strength seen in business surveys. The coming week’s calendar is light but there will be interest in any revision to the PMI January ‘flash’ estimates that showed a sharp pickup from December.
ECONOMIC IMPACT OF THE VIRUS REMAINS UNCERTAIN The majority of Asian equity markets fell again on Friday making it their worst week since last May. Concerns about the spread of the coronavirus continue to dominate and the number of confirmed cases has now passed the reported total during the 2003 SARS outbreak. Both US Fed Chair Powell and the BoE’s Carney noted this week that their institutions were monitoring the economic effects. It is difficult to put a number on the likely effect until its extent is known. In 2003 China GDP initially fell sharply (by 2ppts between Q1 and Q2) but then rebounded quickly. There was also a sizeable impact on the GDP of the rest of East Asia but the global impact was limited. China now accounts for a much larger share of global output and its link into the global economy is greater and more diverse. That points to clear downside risks growth in the first half of 2020, but which could then go away quite quickly. Official China PMI data in January seemingly showed little impact from the crisis. The manufacturing measure was only down modestly to 50.0 from 50.2 in December, while the non-manufacturing index climbed to 54.1 from 53.5. However, it was probably too early for coronavirus effects to show up, particularly as many businesses will have been shut for the New Year’s holiday. The February updates will be seen by markets as potentially more significant. In the meantime, the unofficial ‘Caixin’ January PMIs (Mon & Wed), which are more weighted toward smaller companies, will be watched closely. US 2020 ELECTION ROUND KICKS OFF Monday sees the formal start of the process to choose the next US President as Iowa holds its caucus. President Trump is almost certain to be the Republican candidate on 2nd November. However, who will represent the Democrats is uncertain, as even after several drop outs there are still nine candidates. National opinion polls show former Vice President Joe Biden leading the way with Vermont Senator Bernie Sanders a close second and Massachusetts Senator Elisabeth Warren a more distant third. Iowa will be quickly followed by the New Hampshire primary (11th Feb), then on 3rd March, 12 states including California will vote. With a further 10 states voting on either 10 th or 17th of March, it is possible that the Democrat candidate may be identified relatively quickly. However, the process may be more prolonged if the vote is evenly split between the front runners. As it is 28 years since an incumbent President last failed to be re-elected Trump seems to be in a strong position. Moreover, there appear to be question marks over the electability of all of his potential opponents. However, polls show that the President’s favourability ratings are relatively low compared to his predecessors suggesting that he is vulnerable. The President’s State of the Union Address on Tuesday will give him an opportunity to make the case for his re-election.
US DATA LIKELY TO SUPPORT UNCHANGED RATES As expected this week’s US central bank policy update left interest rates. Fed Chair Powell’s comments suggested that he would be happy for policy to remain on hold for a considerable time. However, he did express frustration that inflation continues to run below target, which markets viewed as a signal that interest rates may be cut later this year. Meanwhile, Q4 GDP growth was reported as 2.1% annualised, the same as Q3. The coming week’s busy US data calendar includes January readings for the labour market and the ISMs. They are expected to be consistent with continued solid growth in Q1 2020 that is unlikely to provoke a near-term move in rates.
EUROZONE DATA CONFIRMS A WEAK END TO 2019 In the Eurozone, this week’s economic data disappointed with Q4 Eurozone GDP showing a minimal 0.1% rise and German retail sales falling sharply in December. Next week’s data for December German industrial production and Eurozone retail sales will probably confirm the weak end to 2019 in the region. However, the key question now is whether things will improve in 2020? Business surveys such as the PMIs have not as yet signalled a pick up, so it will be interesting to see if there is any sign of an improvement in the latest factory orders from Germany.
RBA THE LATEST CENTRAL BANK TO STAY ON HOLD The Reserve Bank of Australia will be the latest central bank to provide a policy update on Tuesday. Until recently markets thought there was a significant probability that the RBA would use the opportunity to cut its interest rate. However, following stronger-than-expected employment and inflation data it is now expected to leave policy on hold. Nevertheless, the RBA is likely to maintain an easing bias and may cite the recent bush fires and the coronavirus as downside risks.
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See you next week!
None of the information in this article is, nor should be construed as financial advice. All foreign exchange transactions involve risk and you should always seek your own independent financial advice before entering into any foreign exchange transaction.