Differences over future relationship to hit Sterling harder

The talks to agree on the future relationship between the UK and EU which includes a comprehensive trade deal will start in the coming days. The animosity that often-added colour to the original Brexit negotiations appears to have carried over into these talks which, arguably, are more important to both sides as they will agree (or otherwise) practical steps towards how the neighbours will work together.

The Prime Minister wants to have a clean break but retain access to the potentially huge EU market. The EU feels that an unregulated supplier of goods and services could upset how the four freedoms work for the rest of the group.

Johnson has used threats that the UK will walk away from the talks without a deal, reverting to WTO trade rules should the talks not take the shape or direction he desires.

Emboldened by his Parliamentary majority which ensures he will be backed every step of the way is causing a degree of concern even amongst ardent Brexiteers. While the previous negotiations, originally marshalled by Theresa May, descended into a farcical shambles, at least there was a degree of oversight.

Confirmed cases of Coronavirus are growing in the UK mostly linked to those who have travelled to Northern Italy. The Government will release its battle plan today which will include outlawing large gatherings and closures of Government buildings and schools.

The overall hit to the economy is difficult to judge as the spread remains likely to be impossible to control going forward.

The pound has reacted badly to expectations of rate cuts. Its initial move higher in late January was due in no small part to expectations that the MPC’s view of the economy was, while not rosy, at least positive.

Yesterday, it fell versus both the dollar and euro. Against the dollar it reached a low of 1.2740, closing at 1.2765. The low over the past few days as the market’s reaction has been strongest, points to a degree of support around 1.2740 as the Coronavirus shock has been dissipated. Versus the single currency, the pound fall was even more dramatic. It reached a low of 1.1448, closing at 1.1463 in moves reminiscent of Brexit’s darkest days

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Powell facing growth versus inflation dilemma

The true effect of the dollar as the true global mode of exchange will be perfectly illustrated over the next couple of weeks. This Friday’s employment report will include the razzmatazz around the headline NFP number but the FOMC, which meets two weeks today, will be most interested in the inflationary average hourly earnings data which combines with producer prices to produce a view of future inflation.

In January, average hourly earnings showed a rise of 3.1% which is quite strong still as the Fed likes to see a 3% increase as good for growth but also manageable. While 3.1% is not significantly above the Fed’s target, it has been rising steadily which is beginning to feed through into inflation. The February increase is expected to be 3.2% which will certainly attract the attention of Jerome Powell and his colleagues.

Faced with the pressure to cut short-term rates to head Coronavirus off at the pass, inflation will be a major consideration. Futures markets are reasonably accurate in predicting Fed actions but far from infallible. Interest rate futures are currently predicting 100 basis points of cuts before the end of Q2.

There is no doubt that the global economy is suffering badly and there is a reversal of the simile that when the U.S. sneezes the world catches a cold going on right now.

Above average growth and a light touch interest rate policy was providing major impetus to the dollar but with growth about to slow, if not collapse, and the Fed likely to start cutting at their meeting which starts two weeks today, the supports for the dollar index are slowly being eroded. Yesterday, the index fell to a low of 97.18, closing at 97.57. To use market parlance, the index had gone up the escalator, moving ahead steadily, but come down in a hurry in the lift.

German data surprises while activity tauper remains

It would be harsh to say that it will be difficult to discern the hit the Eurozone economy takes from the Coronavirus outbreak since growth,if it is there at all, is barely noticeable.

Obviously, the biggest effect has been the positive pressure being exerted on the single currency. Yesterday, it rose to a high of 1.1185, closing at 1.1135. Its overweight rating in dollar index hedges has meant that as the dollar has weakened its effect on the single currency has been magnified due to its 57.6% weight in the basket. A similar story is also true for Sterling (11.9%), but the euro’s rise against the pound is a perfect illustration of the difference.

No one should argue that this move is significantly overdone, and the vultures will begin to circle, as the large funds start to consider the dichotomy between the currency level and the parlous state of the economy. I have talked before about the market finding a way and one-way bets that seldom are, but that seems to be the only positive factor the euro can cling to right now.

ECB President Christine Lagarde spoke yesterday on the need to take measured, appropriate and targeted measures to deal with Coronavirus. These words betray the lack of substance behind them as the market will ask; why have these measures been held back if they are indeed available to the ECB, since the economy has been disappearing down the drain for more than a year. Last September’s rate cuts have proved unsuccessful, so it will be interesting what else the ECB can bring to the table.

Italy has every right to ask why us? Since they took, and continue to take, the brunt of the migrant crisis, although recent actions on the border between Greece and Turkey mean that Greece may be catching up. Most Coronavirus outbreaks around Europe appear to have emanated from a small region of Northern Italy.

Yesterday’s data showed that the economy is neither improving nor deteriorating. Eurozone Manufacturing activity was at 49.2 in February, compared with 49.1 in both January and the markets expectations. German output also rose marginally but it will be a severe test over the next few months. The currency will be a hindrance, although President Trump will probably feel that it is now trading at something approaching par.