Considering the factors 3
Today's news headlines:
- ‘Pimco cools on UK government debt as election nears’. Given the universally extravagant spending pledges heading into the UK election, market participants are carefully re-examining the risk/return of UK debt and finding it wanting. (Financial Times)
- ‘China says it has agreed in principle tariff cuts with US’. Chinese negotiators claim that they have secured a deal to remove some tariffs added throughout the dispute. At first glance, this seems to suggest they’re reverting to a pre-dispute trade dynamic which seems a waste. The US has, however, hedged by saying the degree of tariff rollback will be calibrated based on the extent of deal coverage. This does sound like the administration is exerting pressure aimed at continued progress, which is a positive sign. (Financial Times)
Brexit fog clouds the BoE
It’s been a long time since the Bank of England was able to set monetary policy in the traditional manner, without Brexit casting a fog over potential economic byways. It’s that time once again, and little has changed since the last Monetary Policy Committee meeting in September, so the BoE is likely to project a unified 9-0 vote to keep the UK’s benchmark interest rate at 0.75%. In fact, markets are so indifferent to this month’s meeting that overnight GBP/USD option volatility compared to previous BoE decision days is the lowest in five years. This means the market perceives almost no potential for the exchange rate to move as a consequence of the outcome. Given that the UK’s economic indicators haven’t shifted decidedly in either direction over the past month, members of the committee are probably prepared to wait for the December 12th election outcome and its consequences for Brexit before altering the policy setting.
Today, the central bank will also release its quarterly Monetary Policy Report, which is likely to hint at the effect of differing Brexit outcomes upon their projections for growth and inflation. Back in September, the central bank signalled that repeated Brexit delays might necessitate lower rates due to the effect of uncertainty on-demand, so expect a repeat of this refrain following the latest Brexit extension. As a consequence, Bloomberg is predicting the BoE will house lower growth and inflation forecasts. Let’s face it, even if a deal is agreed, there’s still the transition period to negotiate and the ultimate prospect of a ‘hard-Brexit’ at some point in the future.
Another factor to consider is the effect of uncertainty on business investment, as the UK has persistently lagged behind other G-7 economies since the 2016 referendum and widened since 2017. All in all, BoE policymakers appear to have shifted in a dovish direction. BoE policymakers Gertjan Vlieghe and Michael Saunders have previously said that a deteriorating investment backdrop could result in future rate cuts. Jon Cunliffe has warned of severe downturns due to the constraints of a low interest-rate environment while Silvana Tenreyro cautioned that a Brexit deal would not be enough to justify higher rates.
Bottom line: Looking past today’s decision, some of the spending pledges put forward by both Labour and the Conservatives will certainly concern the BoE. It’s going to be an even more complicated and nebulous exercise to first account for various Brexit outcomes and then overlay the potential economic impacts of fiscal policy approaches. Under this scenario, there isn’t an effective simplification that can be applied to policy, so market pricing is likely to remain firmly in the ‘react to news headlines’ frame of mind until next year when the political fog is expected to lift somewhat... Touch wood.
There has been minimal movement in markets over the past several sessions. Following some Dollar appreciation on Monday and Tuesday, there is virtual stillness in both currencies. The Bank of England press conference takes place this afternoon, which has some potential to move markets depending on the granularity of communication by Mark Carney, et al. This seems marginally skewed to Sterling downside since conversation must really centre on the degree of deterioration under various Brexit scenarios, but expectations surrounding this meeting are exceptionally low.
The Euro was the yin to the Dollar’s yang early in the week and ended up trading lower. Yesterday’s better-than-anticipated Services Purchasing Managers’ Index data had no effect, which gives you an indication of Euro fortunes just now. Sterling, as you might expect, has been pinned to the top of its current trading range and been unmoved by any economic data.
Since early this week, the EUR/USD pair has been sitting stock-still above the 50-day moving average and near the bottom of the four-week range. The market has largely ignored economic data—after the reasonably sound Non-Farm Payrolls data last week—and focused on potential growth locked behind a ‘Phase One’ China trade deal. Another beaten, dead horse; it’s the impetus we have, not necessarily the one we want.