24 June 2022: Government loses both by-elections

GBP – Stunning turnaround, as Conservatives lose 24k majority

It is said that one of the reasons that Boris Johnson was able to cling onto power following a recent vote of confidence was the fact that MPs believed he had a golden touch when fighting elections.

That appears to have now deserted him as well, as the Government lost the two by-elections which were held yesterday.

The first to declare was Wakefield in Yorkshire, where the seat was won back by the opposition Labour Party, who lost it in the general Election.

While this defeat will have stung, it is the kind of result that happens in mid-Parliament and wouldn’t normally have caused too much of a stir given that the turnout was just 39%.

The far more significant result was the Liberal democrat victory in Tiverton and Honiton in Devon. Turning over a 24k majority to lose by a little over six thousand votes will send shockwaves through Westminster. The Liberal Democrats have now taken three seats from the Government in the past six months.

This will be hailed as a return for the UK’s third party following how badly they suffered in the 2016 election immediately following their term in power as coalition partners of the Conservatives.

Questions will be asked, and indeed already have been asked, by the leaders of both opposition parties, about how the Prime Minister can carry on. Despite these significant setbacks, Johnson still commands a majority of 68.

Having held a vote of confidence already this month, another cannot be demanded until twelve months have passed.

There is little doubt that partygate was a major contributor to the result in Devon. Looking deeper into the result, the turnout was down from 71.9% in 2019 to just 52.16% yesterday. It looks like the majority of those who didn’t vote, voted Conservative last time.

While this is a protest vote that could easily be turned over at the next General Election, it is a major bloody nose for the Government and could lead to even more significant injuries to Boris Johnson’s political future.

Data released yesterday showed that the UK fared comparatively better than its G7 partners in June. The S&P composite PMI was unchanged at 53.1 while it was falling in both the U.S. and Eurozone.

The pound continues to feel under pressure and will no doubt feel even more so today as the result of the by-elections sinks in.

It fell to a low of 1.2170 yesterday, but rallied to close almost unchanged at 1.2258.

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USD – Powell prepared to put the economy into recession

Following his two-day testimony to Congress, Fed Chairman Jerome Powell appears prepared to put the U.S. economy into the equivalent of an induced coma in order to avoid any further damage from inflation.

A recession would be the equivalent of such action, as the economy would stagnate for a brief period before coming back stronger. While he won’t admit his concerns over a contraction of activity, Powell’s recent comments appear to see it as the lesser of two evils.

Purchasing managers reports that were released yesterday reveal that the economy is slowing. The preliminary S&P Global Composite PMI for June shows that activity fell from 53.6 to 51.2 as both manufacturing and services output suffered similar falls.

While Powell opened his two-day testimony saying that he was primarily interested in curbing demand since it is the area where the Central bank is able to insert a degree of control. He went on to say how the continuing Covid-19 curbs in China as well as Russia’s invasion of Ukraine are still having a significant effect on supply chains,

While acknowledging the issues with supply, Powell has emphasized that he and his fellow FOMC members are unable to exert any control.

U.S. Investment firm Pimco commented in a note to investors published yesterday, that they calculate that there is a 40% chance of a recession in the next two years and a 10% of it happening in the next twelve months.

This appears to roughly coincide with the message of Powell’s recent comments, which appear to indicate his belief that it is a risk worth taking to bring inflation down to a more acceptable level.

The U.S. markets will have two weeks to chew over the possibility of a recession as well as the expected size of the Fed’s next ,since due to the 1st of July being a Friday, the June employment report isn’t due to be released for two weeks.

This will allow the Bureau of Labor Statistics to produce a more accurate picture of the employment market that will be subject to fewer adjustments.

Yesterday, the dollar index managed to hold onto a small gain for the first time this week. It rose to a high of 104.77 and closed at 104.40.

EUR – ECB fighting the inevitable. Recession is coming

The inflation shock caused in no small part by rising energy prices, the conflict in Ukraine and the effect of supply chain issues has had a significant effect on overall Eurozone output.

The output data released yesterday saw the composite PMI fall to 51.9 from 54.8 in May. Although this is only a little more than was seen in the U.S., it illustrates two significant points.

The first is that the Eurozone is yet to start to raise interest rates to try to combat inflation, while the U.S. is well into its tightening of monetary policy. The second is the fact that the Eurozone and by definition the ECB faces a range of other major issues that will also have an effect on growth.

By the time the ECB meets next, a meeting at which Christine Lagarde will have to fight tooth and nail to keep the hike to twenty-five basis points, there may be a real belief that the region is already in recession in all but name.

Demand remains red-hot throughout the Eurozone, and it will take an enormous effort on the part of the ECB to keep its hike to the level Lagarde wishes to maintain.

German and Finnish Central Bank Heads have already said that they are ready to fight to get the ECB to leave support for the weaker nations aside and concentrate on getting inflation, which the Germans believe is seriously undermining their economy, under control.

They are sure to find support from The Netherlands, Belgium and Austria, which is possibly the most hawkish of the frugal five.

The summer lull is approaching, but conditions will remain volatile through the traditional slow period.

Russia is ready to slow even further the supply of gas, and this is sure to have a knock-on effect on reserves well into Autumn.

Grain supplies are also being hit by the blockade of several Ukrainian ports by Russian soldiers. This could easily result in food shortages across Europe, which will add to inflationary pressures.

The ECB is damned at twenty-five basis points. but also damned at fifty. Since decisions are made in consensus, the coming meeting may well last long into the night, figuratively speaking.

The FX markets appear to be hemmed in at the moment, with small ranges common. The euro fell to a low of 1.0483 yesterday, but rose back above the 1.0520 support to close at 1.0523.