5 September 2022: Pragmatism or Populism?

GBP – The wait will soon be over

Members of the Conservative Party have chosen their new leader. The result of the Ballot will be announced at lunchtime.

There will be little time for celebration for the winner as they get straight down to work on the issues facing the country.

Inflation is currently at 10.1% and is expected to reach 20% as the energy crisis worsens. Rishi Sunak or Liz Truss will be expected to put measures in place to alleviate the suffering, with several charities seeing a choice for some families between heating their homes and feeding themselves.

It is expected that whoever is chosen as leader will announce a package of measures within two weeks of taking office.

Truss, the overwhelming favourite to become the next Prime Minister, showed a degree of naivety recently when she commented that it is the job of the Bank of England to control inflation.

It has become clear over the past several months that the Central Bank lacks the tools to get the job done alone. Monetary Policy alone cannot bring inflation down, since it is not totally driven by demand.

As Boris Johnson ends his tenure as Prime Minister, he leaves with a typically optimistic view of Britain’s ability to deal with the cost-of-living crisis but also a warning about Russia’s intentions towards Ukraine and how the crisis it has brought about will change the entire future of European energy policy.

He believes that the UK has the resources and determination to get through the current crisis and hasn’t yet seen any of the benefits of the deal it fought so tenaciously to achieve (his words).

There were rumours circulating later last week, that if Liz Truss wins the ballot that she will call a snap general election. It will take strong intervention from senior Party members to dissuade her from such a course, as the Conservatives would start campaigning a long way behind the Opposition Parties.

That is a stark reminder of the difference between the two candidates. Truss believes that an election can be won on strength of will, while Sunak is more pragmatic and will want to wait until the last possible moment to go to the polls.

Sterling suffered badly last week as the reality of the economic situation hit home hard. It fell two a level not seen since the first weeks of the Pandemic, reaching a low versus the dollar of 1.1496 and closed at 1.1505.

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USD – Can the FOMC slow down the rate of hikes now?

It is counterintuitive for a lower headline number for new jobs being created would please the Central Bank, but it does mean that its continued tightening of monetary policy is finally beginning to work.

Having hiked rates, in ever larger increments, since last March, the Fed can finally see some light at the end of the tunnel. It was always the case that only when rates ceased to be supportive and reached a neutral point that they would have the effect of restricting growth.

It was claimed over the weekend that over 59% of CFOs who responded to a survey believe that the U.S. economy is headed for a recession this year.

Accountancy firm Deloitte regularly conducts the survey, and this is the first time that it has seen a majority fearing the worst.

The Fed is still going to press ahead with a rate hike this month, and by its own admission, it is unlikely to be swayed by a single dataset. There is a strong possibility that it will still hike by seventy-five basis points, particularly given the continued hawkish tone of Jerome Powell and several of his colleagues on the FOMC.

While there are sure to be some dovish comments from a few Regional Central Banks, Powell will want to continue to tighten policy to be certain that it is having the desired effect.

315k new jobs were created in August, down from a marginally adjusted 526k in July While this is in line with market expectations, it will have given the market cause for thought since it could mark a change in Fed policy for six months.

There have been some calls recently for the Fed to re-examine the effect of its actions since they weren’t having the desired effect on inflation. But with PCE beginning to show signs of falling and now a fall in job creation, all the employment data was lower than the previous month, they will feel that they are on the right track.

Data for activity if the economy will be released tomorrow. It is expected that while both manufacturing and services are slowing, they are still comfortably in expansive territory.

FOMC members Loretta Mester and Lael Brainard are making speeches on Wednesday, Mester is of the hawkish wing of the FOMC while Brainard is considered in her views.

The dollar tempered its recent rally following the jobs report. It still rose to a high of 110.02 but fell back to close at 109.60.

EUR – Is it right to target inflation with the energy crisis looming?

It is expected in some quarters and feared in others that the ECB will hike by seventy-five basis points this week as it tries to get ahead of the curve on inflation.

It is almost certain to be a case of shutting the stable door after the horse has bolted, as inflation is already five times the Central Bank’s target.

The blame for the current situation can, as far as the Bundesbank is concerned, to the change in the target from a firm two per cent to an average of 2%. This gave the ECB a degree of flexibility which, in the opinion of the hawks, was neither necessary nor warranted.

All it did was release the inflation genie from the bottle and has directly led to the current situation. There have been other factors that have driven inflation higher, not least of all the war in Ukraine, while the constant interruption in supply of energy from Russia has played a major part.

With inflation likely to continue to rise even if the ECB hikes rates at every meeting between now and next March, the countries whose economies are really suffering from their inability to borrow at reasonable rates will question the reasoning.

Along with a record rate hike on Thursday, the ECB will also revise its expectation for inflation higher and its growth forecast lower. It is also expected to revise its forecast for employment. This means that their belief is that the one bright spark is likely to be extinguished.

Christine Lagarde, the ECB President, has been accused by members of the Frugal Five, of pandering to the wishes of the weaker economies for tee long, delaying the taper of the support, then waning at least a month too long to begin to hike rates, while those same economies have been crying out for the start of the new tools to ease their borrowing costs,

It will be a fractious meeting this week, and it is possible that no one will leave Frankfurt happy,

The euro was unable to sustain a rally above parity with the dollar and traders lost patience, it fell to a low of 0.9910 but rallied to 0.9952 on the back of the U.S. Employment report.