Broken Records

The past year has been remarkable with political precedents set in the US, UK and France, still record-low central bank policy rates in most developed economies and financial markets and macro data at all-time or multi-year highs (and lows).

The US presidency is fraught with problems but markets turning are a blind eye…for now. The UK is still on course to be first ever member state to leave the European Union come 29th March 2019, at least on paper. French elections have repainted the political landscape and present many opportunities but old (fiscal) hurdles still need to be cleared.

Central bank policy rates remain at record lows in the majority of developed economies, including the Eurozone, UK, Japan, Australia and New Zealand and I expect this to remain the case for the remainder of the year. Loose global monetary policy is likely to continue providing a floor to risky assets, including equities and emerging market currencies.

A number of central banks have hiked 25bp in recent months, including the Fed, BoC and CNB, in line with my year-old view that rate hikes would gradually replace rate cuts. But in aggregate the turnaround in developed central bank monetary policy is proceeding at a glacial pace and I see few reasons why this should change.

The Bank of England has not hiked its policy rate for 526 weeks – a domestic record – and I continue to believe that this stretch will extend into 2018.

In contrast to the Dollar and Sterling, the Euro – by far the most stable major currency in the past seven years – has appreciated over 7% since early April.

While the ECB may want to slow the current rapid pace of Euro appreciation, it is unlikely to stop, let alone reverse, the Euro’s upward path at this stage. For starters, Eurozone growth and labour markets continue to strengthen. The German IFO business climate index hit three consecutive record highs in June-August.

Perhaps the most obvious record which financial markets have broken is the continued climb in US equities to new highs and volatility’s fall to near-record lows.

Emerging market rates continue to edge lower in the face of receding inflationary risks and I see room for further rate cuts, particularly in Brazil given the pace of Real appreciation.

Non-Japan Asian (NJA) currencies continue to broadly tread water, in line with my core view that NJA central banks have little incentive to materially alter their currencies’ paths.

Year-to-date emerging market equities have rallied 24%, twice as fast as the Dow Jones (12%) which has rallied twice as fast as EM currencies versus the Dollar (6%).

Read ‘Broken Records‘ in full on my website.

Advertisements

No UK rate hikes this year and room for further Euro upside

The odds of a 25bp Bank of England rate hike at next week’s policy meeting are all but dead in my view following tepid GDP growth of 0.3% qoq in Q2 2017.

Moreover, UK GDP growth and inflation dynamics, allied to forthcoming changes in the composition of the Monetary Policy Council, point to the record-low policy rate of 0.25% remaining on hold for the remainder of the year.

Forecasting European Central Bank (ECB) monetary policy, including the timing and modalities of changes to its Quantitative Easing program, is arguably a far trickier proposition.

While the ECB may be incentivised to slow the current rapid pace of Euro appreciation, at this stage I do not expect the ECB to try and to stop, let alone reverse, the Euro’s upward path.

Read the full article on my website.

UK: Land of Hope & Glory…but mostly Confusion

The lyrics of Genesis’ 1986 hit “Land of Confusion” were penned over 30 years ago, with the English rock band satirising Ronald Reagan’s US presidency (see Figure 1). Specifically, they allude to the confusion fuelled by opportunist politicians in a fast-changing world beset by acute challenges. But, in my view, they portray with uncanny accuracy the UK in 2017 as Prime Minister Theresa May and her government, Parliament and the Bank of England feel their way towards Brexit.

Read the full article on my website.

H2 2017: Something old, something new, something revisited

As we head towards the second half of 2017 and the one-year anniversary of the UK referendum on EU membership, many themes which have pre-occupied financial markets in the past 12 months are likely to continue dominating headlines.

These include Donald Trump’s US presidency and its longevity, merits and scope for tax reforms and infrastructural spending, Brexit negotiations which officially started on 19th June and the resilience of the ongoing recovery in global GDP growth.

Global GDP growth rose modestly in Q1 2017 to around 3.12% year-on-year from 3.06% in Q4 2016 and a multi-year low of 2.8% yoy in Q2 2016, according to my estimates.

But the global manufacturing PMI averaged 52.7 in April-May, down slightly from 52.9 in Q1 2017, suggesting global GDP growth may not have accelerated further in Q2. This could in turn, at the margin, delay or temper policy rate hikes and/or unwinding of QE programs.

Non-Japan Asian currencies have in the past month been even more stable than in the preceding month, in line with my expectations, but a more pronounced policy change – particularly in China – remains a possibility.

Other themes, such as the timing and magnitude of higher policy rates in developed economies and falling international oil prices, have recently come into clearer focus and will likely be of central importance in H2.

For the UK, I am sticking to my view that a 25bp policy rate hike this year is still a low probability event and I see little chance of an August hike.

The uncertainty over the MPC’s interest rate path and the government’s stance on Brexit complicate any forecast of Sterling near and medium-term but I continue to see the risks biased towards further depreciation.

In France, the hype surrounding Emmanuel Macron’s presidential and legislative election victories is already giving way to whether, when and how smoothly the LREM-MoDem rainbow government can push through its reformist agenda.

Finally, while most European elections are now thankfully behind us, European financial markets are likely to attach great importance to the outcome of Germany’s general election on 24th September.

Conversely, the burning topic of rising European nationalism and future of the eurozone/EU has lost traction following recent presidential and/or legislative elections in France, the UK, Netherlands and Austria.

Read my revisit of H2 of 2017 on my website.

UK Election: Clutching defeat from the jaws of victory

With the votes having been counted for 649 of the 650-seats in the House of Commons, the ruling Conservatives have 318 seats, a net loss of 12 seats. Labour, the main opposition party, won 261 (+32).

Even if the Conservatives win the 650th seat, they will at best be 7 seats short of an absolute majority and 5 seats short of a working majority – a hung parliament.

Prime Minister Theresa May announced that the Conservatives would form an informal alliance with the Northern Irish DUP which won 10 seats. The DUP would support the Conservatives in key votes, likely in exchange for some say on government policy.

Theresa May’s future seems secure for now but medium-term I would expect her position to come under close scrutiny and a party-leadership battle remains a distinct possibility.

Sterling has weakened about 1.5% post election, in line with my and market expectations. The Conservatives’ loss of seats raises serious questions about Theresa May’s leadership, her decision to trigger early elections and the risk of a party leadership battle to oust her.

Moreover, markets will likely remain concerned about the shelf-life of a Conservative-DUP alliance and its ability to push legislation through parliament.

However, I also see scope for Sterling’s downturn to fade and even reverse in due course. To be clear, a V-shaped Sterling recovery would likely remain elusive.

Two key questions pertain to the likelihood of this new Conservative-DUP formal alliance 1) securing an advantageous EU deal and 2) opting for a “hard” or “soft” version of Brexit.

If anything, the past two months have reinforced my view that the government is ill-equipped, ill-prepared and lacking in institutional capacity to negotiate complex deals with the EU and non-EU partners.

The composition of parliament and its take on Brexit leave Theresa May in somewhat of a bind. The government may therefore have little choice but to seek support from some of the 322 opposition MPs who on the whole favour the UK remaining in the EU or at the very least a “soft” version of Brexit.

So while I do not expect a second referendum on the UK’s membership of the EU, I do see a possibility of the government toning down its rhetoric and potentially opting for a softer version of Brexit – a development which UK financial markets would welcome in my view.

At the very least, this election has further weakened the idea that nationalist parties in Europe are gaining the upper hand.

Read UK Election: Clutching defeat from the jaws of victory in full.

UK General Election Scenario Analysis – Impact on Policy, Theresa May and Sterling

In less than 24 hours the British electorate will start voting in the election for the 650-seat House of Commons with the result expected early in the morning of Friday 9th June.

While the last general election was only held two years ago, there is arguably as much if not more at stake this time round than in May 2015.

Opinion polls still point to the ruling Conservatives winning a record-high 44% of the national vote ahead of the opposition Labour Party, but polling agencies which in the past have misestimated true voting intentions still display great inconsistency.

Ultimately it is the number of seats which British parties command which matters and the UK’s first-past-the-post electoral system makes it difficult to predict.

You Gov’s constituency-specific model forecasts the Conservatives winning only 304 seats as a result of a record number of “wasted” votes, a 26-seat loss and well short of both a working and absolute majority. Labour would increase its seat numbers from 229 to 266.

This would result in a hung parliament and either a coalition or minority government.

My own model points to the Conservatives winning around 360 seats (55.4% of total) and Labour 212 seats. Admittedly, this prediction is based on a number of assumptions, namely the net share of votes which Conservatives gain from other parties as well as voter turnout.

Whether the Conservatives significantly improve on their current 330 seats or fail to secure a parliamentary majority remains a tough call and there is an almost infinite number of possible outcomes.

However, I have narrowed down in Figure 10 the number of seats the Conservatives could win to eight possible scenarios, in each case assessing i) Their probability; ii) Their numerical impact on the Conservatives’ majority (or lack thereof); and iii) The risk of opposition parties and/or Conservative backbenchers high-jacking the policy agenda.

Figure 11 assesses for each of the eight scenarios their likely impact on iv) Theresa May’s standing within the Conservative Party and v) Sterling and currency volatility.

Regardless of what happens tomorrow, two events beyond British shores also scheduled for 8th June – the ECB’s policy meeting and Former FBI Director James Comey’s testimony to the Senate Intelligence Committee – will conceivably exacerbate Sterling volatility.

Read ‘UK General Election Scenario Analysis – Impact on Policy, Theresa May and Sterling‘ on my website.

UK Election Special – When Two Tribes Go To War

British voters will on Thursday 8th June vote on the composition of the 650-seat House of Commons – the third major popular vote in two years – after Prime Minister Theresa May’s decision back in April to trigger early general elections.

Theresa May’s motivations were arguably four-fold: (1) Win a popular rather than party mandate, (2) Capitalise on the massive lead in the polls the ruling Conservatives enjoyed over the opposition Labour Party and thus allow her to push through her own agenda, including a possibly softer form of Brexit, (3) Allow the government more time to secure a new EU trade deal, and (4) Strengthen the government’s stance in negotiations with the EU.

Objectives (1) and (3) will likely be met but objectives (2) and (4) may prove more elusive.

Opinion polls point to a trend-fall in popular support for the Conservatives to around 44% and sharp rise for Labour to 35%, with the gap between the two main parties halving to about 9pp from 20pp six weeks ago. Aggregate support for the Liberal Democrats, UKIP, SNP and Green Party is flat-lining around 18%.

However, there is still great discrepancy amongst polling agencies which in the past have misestimated true voting intentions. Moreover the UK’s first-past-the-post electoral system makes it difficult to translate share of votes into seats numbers. Whether the Conservatives significantly improve on their current 330 seats or fail to secure a parliamentary majority, as You Gov currently predicts, is a tough call.

Nevertheless, a number of important themes have emerged in recent months.

First, the slingshot campaign has exposed the frailty and flaws of the Conservative machine, including of its leader and manifesto, and reinforced my view, first set out in December, that the government is ill-equipped, ill-prepared and lacking in institutional capacity to negotiate complex deals with the EU and non-EU partners.

Second, it is a two-horse race between the ruling Conservatives and Labour, with the other parties on course to secure only a modest number of seats – a break with recent elections.

Finally, the political centre of gravity has shifted to the left, with in particular tax rates likely to rise regardless of which party wins next week’s election.

My core scenario is a hollow victory for the Conservatives: 360-370 seats with a low voter turnout. This would reduce the risk of opposition parties and rebel Conservative MPs torpedoing government legislation but would fall short of the landslide victory which Conservatives thought possible back in April.

Finally, a modest (or even significant) increase in the Conservative’s parliamentary majority is unlikely to materially improve the government’s hand when negotiating with the EU.

Read UK Election Special – When Two Tribes Go To War in full on my website.