Late last week, we learned that the Bank of England’s Monetary Policy Committee had changed its tack since the coronavirus had begun. Under the previous Governor, Mark Carney, its stance was to raise interest rates before starting to reduce the size of its quantitative easing asset purchase program. Since dropping rates to near 0.0%—and with little appetite for negative interest rates—the bank is using its asset purchases as the key lever for monetary controls. It’s worth noting that the BoE’s balance sheet has risen by approximately 40% since February to 25% of UK GDP or £686bn.
As the next phase of lockdown restriction easing draws near on the 4th of July, the UK Chancellor Rishi Sunak is looking forward to additional stimulus measures to lighten the pressure on UK businesses and spur spending. Over the weekend, we learned that a VAT reduction is being considered—an expensive measure used after the global financial crisis in 2008—but would ultimately lead to a tax hike in late Autumn. At the same time, Boris Johnson and Michel Barnier appear to be making headway towards a negotiable middle ground on several disputed items, which have been obstacles in making a 2020 agreement. For both the retail sector and EU negotiations, it's too early to tell whether the outcomes will be as positive as the news headlines might lead us to project.
Across the pond, the Federal Reserve has also taken some very drastic action since the coronavirus episode began. It too has dropped interest rates to near 0.0% and increased its balance sheet, except the scale is much larger than the UK. In the past three months, the Fed has increased asset holdings by 70% to roughly 30% of US GDP or $7tn and is making moves towards Bank of Japan-style equity purchases, which some argue is tantamount to part nationalisation of the US economy.
Unlike the UK, the US was faster off the block in reducing lockdown restrictions—though the measures are varied on a state-by-state basis—which has led to significant infection rate increases last week, raising the risk of a second wave. Perhaps surprisingly this has started to hit President Trump's perceived handling of the crisis—with additional pressure from Black Lives Matter protests—presenting an assault on his bid for re-election in November.
Last week we also received reports of John Bolton’s tell-all of the Trump Administration—which is unlikely to change opinions of Trump voters—but does focus the spotlight on several issues. One of these is an alleged scheme by Trump to use Chinese agricultural purchases to help secure his bid for re-election. On June 28th, the National People's Congress is set to impose a national securities law that represents a takeover of administrative and judicial reins in Hong Kong, which erodes a key requirement for special treatment by the US. It will be interesting to see whether the US President will tread lightly on the Hong Kong issue to protect his agricultural purchases and if that ultimately sets him up to further controversy.
Bottom line: This week’s article seems like a series of unconnected stories, but the thread that runs through them is an escalation of risk. Both US and UK central banks are increasing asset purchases to historic proportions and are set to go even further. The Johnson government is walking a fine line by trying to stave off economic fallout and negotiate a Brexit deal in two months. And there are also a series of US political blunders coming home to roost in the run-up to the 2020 election. The crux of this tale is not just on any one of these threads, it's that they all exist at the same time, and each has a potentially large consequence at the end of it.
The week ahead
Last week, Sterling started on firm footing, climbing close to 1.27 against the US Dollar and breaking the 1.12 level against the Euro. However, on its trade-weighted index, the Pound failed to close above its 50-daily moving average on Tuesday and fell over 2.0% through to Friday. Sterling shows signs of a recovery as we begin the week anticipating Boris Johnson’s announcement for further easing of lockdown rules to start on July 4th. The reopening of pubs, restaurants and hairdressers combined with a relaxation of social distancing measures would increase the UK economy’s cash-flows in wages and spending and could provide a short-term boost for Sterling.
The Euro extended losses last week after peaking against the US Dollar at 1.1422 in the middle of June. The common currency had experienced a significant sentiment boost in recent weeks following a promising coordinated fiscal package within Europe. However, being one of the first regions in the world to relax lockdown measures, signs of a second spike in the area are growing. This coincided with a brief rally in safe-haven assets last week, and could be a sign of things to come as other nations around the globe relax lockdown measures.
Last week the US Dollar gained while risk-assets were shaky over growing concerns of a second coronavirus wave across the globe. The trade-weighted US Dollar index reached three-week highs and the US Dollar gained nearly 3.0% against the Pound last week. The deterioration of the pandemic in the US and election rally outcomes are likely to be drivers of the US Dollar over the medium-term as well as broader risk sentiment driven by the consequences of reopening economies worldwide. On Thursday, the Federal Reserve will release the latest stress test results on 34 of the US’ largest banks.
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