13 January 2025: Deutsche Bank advises short GBP positions

The Chancellor has defended her decision to travel to China to meet high-ranking Government officials to bolster the two countries’ trading relationship.

Rachel Reeves has announced that she has reached several agreements with Asia’s manufacturing powerhouse worth six hundred million pounds.

While she has been out of the country, there has been close to turmoil in the financial markets, with the country’s borrowing costs rising to decades-long highs.

Meanwhile, the Treasury has defended her decision to travel despite the upheaval. At the same time, the OBR has stated that while additional volatility is affecting several nations, the market is functioning “normally.”

Reeves is facing some tough decisions if the current turmoil continues. She has already stated that the self-imposed fiscal rules are “non-negotiable, and she has no intention of “moving the goalposts to allow herself room to borrow more.

This means she may be left with two equally unpalatable options. The first would be to cut Government spending which would lead to cuts in the welfare budget or services, or even both, or raising taxes.

Both these options would be poorly received by the market, although Reeves has already shown herself to be prepared to make unpopular decisions as she continues her quest to provide a solid foundation for the country’s finances.

Shadow Chancellor, Mel Stride, appeared on TV yesterday and was unsurprisingly heavily critical of Reeve’s decision to travel when she needed to show herself to have confidence in the market.

He was also critical of the Government’s performance which, he believes, has led to the current turmoil, even as it was pointed out to him that several Conservative Chancellors also visited China to try to drum up business opportunities.

He was also dismissive of the fact that the last time the markets saw similar turmoil, it was following Kwasi Kwarteng’s mini-budget during Liz Truss’s ill-fated term as Prime Minister.

While it is true that several nations including the U.S. and Germany are seeing their borrowing costs increase, the situation has been exacerbated by the current lack of growth in the economy and rising inflation.

The economics team at Deutsche Bank in London has advised clients to either establish short positions in Sterling or maintain positions that they have already taken, since they are concerned about bond yields and weakening economic indicators, including recent Purchasing Managers’ Index (PMI) data that revealed “another sharp drop in business employment expectations. This downturn could prompt the Bank of England to consider lowering interest rates despite rising inflation.

The pound saw a sharp downturn last week, falling to a low of 1.2191 and closing at 1.2209.

While Donald Trump has a robust economy to “play with,” there are growing concerns that his overtly protectionist policies may well contribute to a fall in growth, economic output, and productivity as well as a rise in inflation.

The FOMC is expected to react to this uncertainty by leaving interest rates unchanged when it next meets on January 28/29.

The uncertainty that has been created by Trump’s desire to add tariffs to U.S. imports of finished goods from several countries has caused the Managing Director of the IMF to comment that the global economy in 2025 faces heightened uncertainty due to economic policies, particularly the directions of U.S. trade policy.

Kristalina Georgieva went on to say, “Not surprisingly, given the size and role of the U.S. economy, there is keen interest globally in the policy directions of the incoming administration, in particular, on tariffs, taxes, deregulation and government efficiency,”

“This uncertainty is particularly high around the path for trade policy going forward, adding to the global economy’s headwinds, especially for countries and regions that are more integrated into global supply chains,” said the IMF chief.

She also pointed out a shift in market expectations, which leads to knock-on effects on asset prices and exchange rates being seen currently in the U.S. UK and Eurozone.

A strong dollar, both against advanced economy currencies and against emerging market currencies, could potentially “fuel higher funding costs for emerging market economies, especially for low-income countries.”

The December employment report was delivered on Friday. It showed that 256k new jobs were created in the final month of last year, up from a downwardly revised figure of 212k in November. The unemployment rate fell to 4.1% from 4.2%.

This added to the likelihood that the FOMC will leave interest rates unchanged.

Jerome Powell probably breathed a sigh of relief in the sense that his job just got a little bit easier. Inflation has not been moving anywhere for months, so there is no incentive to cut rates., while this jobs report shows that the economy needs little incentive to continue growing at a healthy rate.

The report brings to a close a year in which employment grew each month, though inconsistently and at times raising questions over whether a recession loomed. However, the final two months showed that the labour market was still operating at strength as the Fed contemplated its next moves on monetary policy.

The dollar index continued its inexorable rise to meet its medium-term target of 110. On Friday it reached 109.97 but drifted back to close at 109.65 as President Trump’s inauguration moved ever closer.

The Eurozone is moving ever closer to two elections that will shape its short to medium-term future, While the French election is still some way off, the Federal Election that was called in Germany following the collapse of its coalition government and the loss of a vote of confidence in Olaf Schmidt as Chancellor will be held next month.

The election is likely to produce another stalemate, which, at the end of the day, is the desired outcome of proportional representation as a voting method designed to produce a broad-based Government.

According to the latest “Deutschlandtrend” survey, the balance of power in Berlin is set to shift significantly in Germany’s upcoming federal election, which takes place on February 23.

The centre-right bloc of the Christian Democratic Union (CDU) and Bavaria’s regional Christian Social Union (CSU), which governed in Germany for most of its post-World War II history but is currently in opposition, has lost two percentage points compared to last month but is still ahead of their competitors at 31%.

The far-right Alternative for Germany (AfD) is in second place at 20%, and Chancellor Olaf Scholz’s Social Democrats (SPD) comes in third at 15%, just ahead of the Greens (14%).

According to Chief Economist Philip Lane, the European Central Bank (ECB) is expected to reduce interest rates further to maintain its price stability mandate.

Speaking at a conference in Hong Kong earlier today, Lane noted, “Probably more monetary easing is going to come to make sure the European economy grows.” He added that without additional policy adjustments, “delivering on our inflation target would be at risk.”

Members of the ECB’s Governing Council are currently evaluating the pace and extent of interest rate cuts for 2025, following four quarter-point reductions last year.

While further easing seems likely, some more dovish officials have suggested a potential fifty basis-point cut, acknowledging the various risks facing Europe’s sluggish economy.

The latest data revealed inflation rose to 2.4% in December, but the ECB maintains it expects consumer-price growth to return to its target of 2% later this year.

The euro-area economy grew by just 0.7% last year, with forecasts suggesting a modest acceleration to 1.1% in 2025. However, the risk is still to the downside, although the market believes that Christine Lagarde and her colleagues have been slow to acknowledge that fact.

For the rest of the first quarter of the year, the political situation in Germany will vie for the market’s attention with the economy.

While the U.S. and in particular the return of Donald Trump to the White House will command the most attention, the actions of the ECB will be the hardest to predict, given the sheer number of representatives on the Governing Council and their wide-ranging vows on the economy and monetary policy.

The Euro continued its descent towards parity with the dollar last week. It fell to a low of 1.0213 and closed at 1.0244.

Have a great day!