In for a pound
- Summer markets remain quiet, but macro trends never sleep
- Loose central bank policy could boost infrastructure spending
- Post-Brexit selloff in UK assets may be overblown
By Neil Staines
“You and I travel by road or rail, but economists travel by infrastructure” – Margaret Thatcher
This week got off to the kind of start where you would be forgiven for thinking that a large proportion of the market was on holiday (or watching the Olympics). The relative calm in financial markets, however, perhaps gives us an opportunity to reflect on the global macroeconomic backdrop and the possible opportunities for the rest of 2016 and beyond.
As monetary policy reaches the end of its impactful cycle, the baton for growth-inducing policies has been clearly passed to governments and to fiscal policies. With around two thirds of G20 nations planning fiscal loosening, it is possible, if not probable, that the next global boom is in infrastructure.
“Keep your face to the sunshine and you can’t see a shadow” – Helen Keller
Without a doubt the UK qualifies for its own section in this discourse. Renewed monetary accommodation from the Bank of England has seen real yield differentials and pretty much all relative rate differentials plumb new lows, resulting in renewed downward pressure on GBP.
However, while policymakers warn of the impending economic deterioration of the post-Brexit UK, it is worth noting that much of this negativity is a function of what can only be described as preliminary confidence surveys at a sectoral level.
Ian McCafferty (until recently considered one of the BoE's monetary policy committee hawks) suggested today that if the UK economy slows “in line with initial survey signals, I believe more easing is likely to be required”. However, with so much of the negative growth expectations based on extrapolating short-term hits to consumer and business confidence, we would emphasise the risk that confidence can return as quickly as it dropped.
Last night’s BRC retail sales data for July is a case in point, highlighting that it only takes a little sunshine to boost retail activity sharply above expectations.
“You were the sale of the century” – Sleeper, Sale of the Century
This morning’s UK data are arguably less relevant in assessing the post-Brexit UK as the data were for June. However, we would argue that the weakness in both manufacturing production and more broadly in net trade would have been significantly impacted by expectations. For example, having been warned by the BoE and just about every commentator on the planet that a ‘Leave’ vote would bring a substantial decline in GBP, it would not be surprising to hear that foreign companies (at least those with some pricing power or flexibility) decided to delay non-essential UK purchases (even at the margin) on the basis that there may be a significant discount for doing so.
If this was the case then we might expect that there will be a significant rebound in the purchase of (exchange rate driven) discounted UK goods and services over coming months. We shall see.
We retain our view that the UK (consumer and business) is more resilient than the market is pricing in, and while we have clearly pointed out the negative implications for GBP in the near term, we retain a view of renewed UK and GBP outperformance going forward.
We are increasingly close to the trigger point, which must come in the form of economic good news relative to expectations.
“To call this a recovery is an insult to recoveries” – Mitch McConnell
Another significant driver of global financial markets is the continued debate over Federal Reserve policy. Friday’s US employment report for July highlighted further strength in the depth of the labour market recovery.
Perversely, the bigger-than-expected jump in payroll gains, as well as the lack of acceleration in wage growth, led some Fed members to the dovish conclusion that there is more labour market slack than they had expected - thus the equilibrium rate of unemployment is lower, along with the urgency to hike.
However, the market increased the probability of a September rate hike to around 30%. We retain a positive view on US growth, rate expectations and the USD, despite the stubborn dovishness from (at least part of) the Fed.
The rest of the week is unlikely to spring into action and we would expect activity to remain fairly light. Against that backdrop, the commentary from the Reserve Bank of New Zealand tonight, that accompanies what is generally accepted to be a 25 basis point rate cut, is important for the progression of monetary policy in New Zealand, and likely relevant to Australia.
As credit risks and overcapacity continue to drive a lower CNY and increased exporting of deflation, we would anticipate that countries with substantial reliance on trade may become increasingly vulnerable. Particularly if, as we would expect in Australia, further rate cut expectations begin to rise again.
With regard to GBP, we may have to see the signs that the government is signalling significant infrastructure projects as one of our barometers to go “in for a pound”.
— Edited by Michael McKenna
Neil Staines is head of trading at The ECU Group