11 November 2022: Hunt planning spending freeze

GBP – MPC doves must state their case more forcefully

Kwasi Kwarteng appeared from self-imposed exile yesterday to reveal that he warned Liz Truss that she was moving too fast with reform that she wanted to introduce in the immediate wake of her election as Conservative Party leader.

He said his policies tried to drive the economy forward and warned Rishi Sunak over the likely rise in taxes.

Kwarteng appears to have failed to grasp the severity of the situation facing the UK economy, and still has no answer to questions about how his plans were to be funded. The single lack of understanding came close to derailing the entire financial system, as pension funds came close to being forced to sell off longer-term assets which are the cornerstone of their portfolios.

It was a veiled criticism of Kwarteng’s inexperience when Andrew Bailey spoke recently of how much harder it is to regain the market’s confidence than lose it in the first place.

Jeremy Hunt will deliver his plans for repairing the hole in the UK’s finances to Parliament next Thursday. Although he may provide a mixture of spending cuts and rises in taxation, it is believed that he plans a freeze on public spending, which the Opposition will challenge as a return to austerity.

The new Government team almost feels like an election has taken place as they begin to put in place policies designed to drive the economy forward, but not until they have fixed the issues that remain following the wasted years since the 2019 election.

Today will see the publication of the GDP data for the period between July and September. It likely heralds the beginning of a recession, as the economy shrunk by 0.5% in Q3 following 0.2% growth in Q2.

The Pound revelled in the US midterm election results and the subsequent rise in risk appetite. It climbed to a high of 1.1715, closing close to that level.

Having broken the resistance at 1.1680, a weekly close above that level will see a new medium-term rally begin.

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USD – A timely nudge to the FOMC

The US economy is beginning to see inflation fall, despite individual components pointing to a continued rise.

The data published yesterday for CPI showed that headline inflation fell in October from 8.2% to 7.7%. It is possible that as time goes on and the Federal Reserve’s continued increase in interest rates takes the fed funds rate well into restrictive territory, that inflation will fall more quickly.

Jerome Powell has remained hawkish even after four consecutive seventy-five-point hikes, but that may soon end.

Earlier Fed Chairman introduced a waiting period to allow the effect of rate hikes (or cuts) on the markets to be seen. That effect is by no means instant, and it takes roughly the time between meetings to see the previous actions take full effect.

Added to recent hikes is the effect of the reduction of the Central Bank’s balance sheet, which is gradually taking place behind the scenes.

The employment market is still running hot, as shown by the October headline figure for new jobs created.

The results of the midterm election have yet to be declared. As the Republicans edge close to a majority in the Senate, the House of Representatives looks likely to be evenly split.

The election process has turned out to be a damp squib for the Republican Party and its self-proclaimed leader, Donald Trump. While several of his supported candidates could not overcome their Democrat opponents, Trump has already turned his attention to his probable candidacy for the 2024 Republican nomination.

It seems that he wants to cement his apparent popularity by being nominated unopposed, and for that reason, is continuing his very personal attacks on the Florida Governor Ron DeSantis may also run.

The Dollar Index reacted badly to the probable result of the election, as risk appetite rose significantly. It fell to a low of 107.71 and closed at 107.86. A weekly close around this level could open a deeper correction, targeting support around 105.

EUR – Rates will continue to rise as inflation still is above 10%

Officials at the ECB and the European Commission appear to agree that inflation may peak before year-end but are less optimistic about when prices will begin to fall.

The current rate of inflation, which reached a record 10.7% in October, is due mainly to matters beyond control of the Central Bank.

The ECB is behaving as Central Banks do when faced with rising inflation by tightening monetary policy to bring down demand. The problem is that demand is already being hit by the energy crisis and the continued economic slowdown.

There is a continued battle being fought by the doves and hawks on the governing council of the ECB, which for now, is being won by the hawks. Short-term interest rates were hiked by seventy-five basis points recently, and it is expected that a similar level of hike will be agreed upon at the next meeting, early next month.

There appears to be little prospect of an end to the conflict that continues to rage in Ukraine, despite the optimism that greeted the news that Russian was withdrawing its troops from the city of Kherson. One of its major targets at the start of the war.

It now appears that while the troops are leaving, Russia will redeploy them in a new offensive in the Donbas region. Until the fighting concludes and energy prices stabilise, inflation will remain high, and the EU economy will suffer a downturn.

The Euro is creating a false dawn, rising above parity with the Dollar. There has been no reason to buy Euros, other than for commercial reasons, for several months. Nothing has happened to change that view. The current rally may extend a little further which the Dollar continues to correct, but the year-end prediction is for it to end below parity again.

Yesterday, it rallied to a high of 1.0197 and closed at that level. One factor in its favour is the fall in US inflation, which may precipitate the Fed to slow the pace of rate increases, while the ECB presses ahead with further hikes.