Brexit and other trade deals key to long term recovery

The entire global economy has been blown so severely off course by the Coronavirus Pandemic that this entire year is going to be a write off. Several nations will have to wait to pick up where they left off at the end of last year, none more so than the UK which needs to press on with its post-Brexit trade agreements.

Negotiations between the UK and EU about the post-Brexit relationship have been blighted by a potential issue over the right of UK haulage. The UK wants the current arrangements to be honoured while Brussels says that tilts the deal too far in favour of the UK.

Waiting in the wings are potential deals with Australia, Japan and, of course. the U.S. President Trump has been dangling a carrot in front of Boris Johnson for some time but as is always the case it comes with strings attached.

Trump’s ability to deftly move the goalposts means that the UK’s decision to ditch Huawei as a condition of agreeing a trade deal with Washington may not be enough should he be re-elected. With the election being far from certain, the UK will need to be aware of what Democrat Candidate Joe Biden will expect in return for a deal should he win in three months’ time

The UK’s ability to trade on competitive terms will be key to its long-term recovery from Covid-19 but short-term, there is still a mountain to climb.

Fears of a second spike as the country’s response appears to be fractured, the slow demise of the high street which is shedding jobs at an alarming rate, Government support packages that will need to be reviewed and possibly renewed and the continued search for an effective vaccine mean that pressure on Boris Johnson and his team is likely to increase.

Meanwhile positivity from Treasury and Bank of England officials continues to provide support to Sterling, although its current level is just as much a reaction to a weaker dollar.

Yesterday, it climbed to a high of 1.3267 but the possible beginning of a dollar correction spurred by the FOMC minutes (see below) saw it drop to close at 1.3099. The 1.30 level remains crucial and unless there is a close below that level this fall can be considered a correction.

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Inflation and employment to be targeted before any rate rise

As we said yesterday, FOMC meetings and their minutes always have the potential to provide the markets with a jolt.

As expected, the headline from the minutes released last evening was of support for the economy and the Fed’s commitment to doing whatever is necessary.

However, as if often the case, the devil is in the detail and that again proved to be the case. There was an apparent disagreement over the use of bond purchases to decide the shape of the yield curve and while the detail remains to be fleshed out, any sign of a less than unified FOMC is a red flag for the market.

There was also an initial discussion about what the Fed’s plans will be once the economy is back on track and rates need to be raised. Advance Guidance is always a difficult call as it can either tie the hands of the FOMC or cause a loss of confidence should circumstances change.

The Fed Chairman has, so far, deftly controlled the level of advance guidance given to markets and this has been a trait that traders appreciate.

There was discussion of switching to an outcome-based policy where targets are released for inflation and employment once monetary policy needs to be tightened. This did not meet with uniform approval and the dollar started to rise as risk appetite waned.

Today’s jobless claims figures will take on a new dimension given yesterday’s price action. With the initial claims data dropping below a million last week a continued improvement is expected. However, continuing claims appear to have stalled around fifteen million and some movement on the relief fund may be needed to solve what could be becoming a logjam.

Yesterday, the dollar index rallied on the back of the FOMC minutes. It reached a high of 93.05, closing just two pips from the top. It will need to continue through the 94 level for its recent weakness to be considered at an end.

Markets see a top developing as the dollar finds a base

The euro has been defying gravity for some time, but it is well known that a large part of that strength has been derived from a weakening dollar and the single currency’s weight within the basket.

As the Eurozone economy recovers from the Coronavirus pandemic, assuming that there is no significant region-wide second spike it will want to use trade and more specifically exports as a means towards that recovery.

A continually strengthening currency would harm that recovery. Although it is likely to be some time before the currency is considered the only impediment to growth, the ECB will want to exert greater control over its level. However as is true in most cases the Central Bank lacks the tools to be able to fulfil that need.

The longer-term issues facing the Eurozone are well documented. It is unlikely that they will start to be addressed until the distribution of the relief fund is well under way, and its effects are better known.

Brexit will play a part in the future for the region almost as clearly as it will in the UK. A large proportion of the supply chain for EU manufacturers is fulfilled by the UK and that will technically add to the level of imports post-Brexit, just as more intra-EU trade is being promoted.

No matter the wrangling for a better deal both sides are well aware that whatever the words on paper say, the relationship between the two will be close if not always cordial.

Tomorrow PMI data will be released for the Eurozone and just as importantly Germany. It is expected that the recent rise will continue, and growth will be maintained. There is a slight concern about the composite Eurozone PMI which may stall although it should remain at a healthy 54.9.

The euro fell yesterday as the dollar recovered. It reached a low of 1.1830, closing at 1.1837. It has some way to go before the recent rally can be considered over. Major support is at 1.1700.