22 July 2022: Tory infighting may weaken response

GBP – Main protagonist squabbling rather than settings out plans

It is a rather typical outcome of election campaigns in the UK that the candidates spend more time trying to discredit their opponent’s plans than they do promoting their own.

The race to be the new leader of the Conservative Party and therefore Prime Minister of the UK is beginning to take an all too familiar tone.

Both Rishi Sunak and Liz Truss plan to cut taxes. This is likely to be a vote winner, but it is the timing of the cuts that is the bone of contention.

Truss is of the opinion that there is room for tax cuts to be initiated immediately. She commented yesterday that the policies of the Johnson Cabinet, of which she was a member and her opponent was Chancellor, held back economic growth in the country and contributed to the current slowdown in output and activity.

Her remarks have been ridiculed by Sunak supporters who believe that if Truss was the principled politician she claims to be, she should have resigned rather than accept policies which were against her expectations.

The Sunak campaign has hit back at the fantasy of non-inflationary tax giveaways that they are adamant are impossible to achieve.

Outside the timing of tax cuts, there is very little being reported about any other policies on which they differ.

Foreign Secretary Truss has extended her lead over Sunak as she concentrates to take aim at Sunak’s record as Chancellor, despite the plaudits he received for his actions in initiating the furlough payment scheme during the Pandemic lockdown.

Truss’s promised £30 billion tax cuts are so far unfunded which means Sunak is questioning where the money will come from, since when he was Chancellor, no such nest egg was sitting in a cupboard anywhere.

The most recent data which showed that the economy grew, even marginally, has done little more to delay what many analysts believe to be an autumn/winter recession.

It has been evident this week that petrol prices are beginning to stabilize and in many areas beginning to fall. That will have a significant effect on headline inflation that has been out of control for several months.

The pound appears unsure of its short-term direction as it hovers around the 1.20 level. Yesterday, it fell initially to a low of 1.1890 but recovered to close at 1.1984, having run into selling as it clawed its way above 1.20.

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USD – Powell sticking to his guns

It has been a familiar story for several months that the FOMC is not going to change its monetary policy stance until it has inflation under control. Accused by many of being late to the party, the Fed has enacted ever larger rate hikes with little obvious effect on headline inflation, which appears to be bound to hit double figures.

Mortgage rates in the country are now above 5%, currently at 5.3%. This will inevitably have the effect of slowing the housing market, since it will deter those who have no particular reason for moving house, to stay put until either the uncertainty has passed or rates return to lower levels.

On the other hand, the spectre of unemployment is not a current issue and until that situation changes, the lull in house sales may be seen as little more than a blip.

It is common to see comments from analysts pointing to this or that indicator pointing to significant slowdown in activity. But so far these predictions are not coming to fruition.

It is generally that every recession is different and has its roots in slowing activity in a particular sector. The current slowdown, which may or not turn into a genuine recession is rooted in the supply side of the economy, which in itself is unique, and can be blamed on the fact that the U.S. has exported the vast majority of its manufacturing capability.

The accepted version of a recession is two consecutive quarters of contraction in the economy. The term negative growth makes no sense, and is falling out of favour. It is unclear where this term originated, since it is a product of any Central Bank or statistics agency.

If there is to be a technical recession, it is likely that it has already started. With the economy having contracted by 1.6% in the first quarter, it is more than possible that it has contracted by a similar amount between March and June.

Such a scenario will have no effect on the Fed, and a seventy-five-basis point hike next week will almost certainly be followed by another in September. There is no FOMC meeting in August.

Having reached several targets in recent weeks, the currency market appears to have entered its summer phase in a fairly directionless state. The underlying trend remains forma stronger dollar, but using the Fed’s continuous policy of rate hikes to prove the theory is turning stale. Until there is a significant new driving force, in either direction, the market will remain in tight ranges.

Yesterday, the dollar index traded in a range between 107.33 and 106.40, closing at 10.04. Technically, it is building strong support around the 106.50/60 area, although there is residual selling interest around 107.40.

EUR – Rise in rates considered a drop in the ocean by market

It had been considered in the weeks/months leading up to yesterday’s ECB meeting that a fifty-point hike would see the euro receive a boost, while twenty-five would see its journey south accelerate.

In the event, a hike of fifty basis points saw the euro lose ground but not to any large degree. This was probably due to the fact that in her post-meeting press conference, Christine Lagarde was neither dovish about a future hike nor sufficiently hawkish to make the market believe that the Bank had embarked on a concerted path to bring inflation under control.

The Central Bank’s new tool to ensure that fragmentation between the borrowing rates demanded from Eurozone states doesn’t become too wide was officially named yesterday. Lagarde’s new baby will be called the Transmission Protection Instrument, but we can call it TPI for short.

Essentially, this means that if borrowing costs become out of line in one or two states, the ECB will step in to provide some form of guarantee to the lender. This is going to see some significant teething problems, since each time there is a two-tier market, issues arise.

The first outing for the TPI may be to protect Italy. With the Prime Minister Mario Draghi finally prevailing upon the President to accept his resignation, Sergio Mattarella dissolved Parliament.

It remains to be seen if Five Star, the largest Party in the now dissolved coalition, will be able to garner sufficient support to rule alone.

If that is achieved, Italy will see another lurch to the right, as Five Star has a well-known apathy towards Brussels.

In providing more detail about TPI, Lagarde confirmed that it will buy bonds with remaining maturity between one and ten years and purchase will be terminated upon a durable improvement in transmission or based upon an assessment that persistent tensions are due to a country’s fundamentals.

Therefore, if the market appears to be irregular due to the market’s perception, TPI is applicable. However, if spreads rise due to financial indiscipline, like rising debt to GDP ratios or a significant rise in budget deficit, such support as TPI can provide will be withdrawn. In other words, behave or you’re on your own!

The euro didn’t really react to either TPI or Lagarde’s speech. It rose initially to a high of 1.0277, shaking out a few remaining shorts, but then fell back to close at 1.0230.