'There is but one rule: Hunt or be hunted'
- Otmar Issing's EU criticism is a noteworthy departure
- Mario Draghi may retain or even extend QE parameters
- Signs of imminent govt. policy intervention in US and UK
- UK chancellor likely to abandon balanced budget target
- Risks to GBP are increasingly to the topside
With all the politicking and positioning going on on both sides of the Brexit debate it is interesting to hear the views and comments of one of the founding architects of monetary union and the first chief economist at the European Central Bank, Otmar Issing.
“One day the house of cards will collapse” – Otmar Issing
Ahead of this week’s ECB meeting Issing expressed his view that the “European Central Bank is becoming dangerously over-extended and that the whole euro project is unworkable in its current form.” He also stated that “the euro has been betrayed by politics that has degenerated into a fiscal free-for-all” and that the EU itself is a “House of Cards...The moral hazard is overwhelming”.
“Friends make the worst enemies” – Frank Underwood, House of Cards
Herein lies a distinct issue for the UK in its Brexit negotiations, provided at some point the government can come up with a coordinated strategy – there is a distinct lack of unity and consensus within the EU.
Broad market focus will fall back on the Eurozone this week with the ECB meeting on Thursday. Recent weeks have seen a re-emergence of EUR short positioning, a lower EUR and a steeper European yield curve. In isolation, these two events are rarely correlated. The bond market moves likely have more to do with rising rate and inflation expectations in the US, and the curve targeting in Japan, than an expectation of tapering, inflation or higher yields in the Eurozone. In that regard we would expect ECB chief Mario Draghi to reaffirm, if not extend, the expected duration of asset purchases under the current round of QE.
“Democracy is so overrated” – Frank Underwood
We have discussed on many occasions over recent months our view that monetary policy is (or has) reached its useful limits globally and that markets, forecasters and policymakers will increasingly shift their attentions to national governments in the search for "growth friendly" fiscal loosening. On both sides of the Atlantic at the moment there are also rising signs of potential government intervention in monetary policy – further confusing the policy debate.
Fed board member Stanley Fischer continued to debate the non-linearity of monetary policy at, or close to, the lower bound yesterday evening stating that “operating close to zero may undermine confidence” (a factor that, potentially more importantly, also applies to central bankers in relation to financial stability). Fischer also expressed his view that expansionary fiscal policy (and waning investor caution) could lift the natural rate. This is a concept that we would agree with - confidence is the key and higher rates bring benefits as well as restrictions.
“Proximity to power deludes some into thinking they wield it” – Frank Underwood
On the fiscal side, the UK Autumn Statement on November 23 is likely the key barometer of how the establishment views the need for fiscal policy to pick up the baton. Chancellor Hammond will almost certainly abandon the 2020 date for a balanced budget, yet it remains unclear how bold the "genuine" fiscal easing measures will be, beyond the automatic effects of a lower GDP forecast on the budget, and the higher gilt yields on interest servicing costs which tighten policy by default.
This brings us fairly neatly on to GBP. The decline in the pound since the ‘Leave’ vote in the UK’s EU referendum has been sharp and significant. The magnitude of the decline however, is now beyond that which would be expected to compensate for the negative implications (under the ‘hard’ Brexit economic projections by both the Treasury and the IMF) on GDP growth, productivity and yield differentials. Our long-term fair value models retain GBP valuations significantly higher than they are today. With sentiment, positioning and perhaps most significantly political uncertainty extended to the downside, we are clear in in our opinion that the risks to GBP are increasingly to the topside.
“There is but one rule: Hunt or be hunted” – Frank Underwood
Yesterday’s bond market bear rally was halted by further weakness in the Empire State manufacturing index and while this highly volatile series by no means constitutes a US economic prosperity bellwether, it does serve as a reminder that Fed chief Janet Yellen may well be considering letting the US economy run hot, but it has to get there first.
This filtered through into a weaker USD overnight, as a higher than expected inflation reading from New Zealand and a less dovish than expected Reserve Bank of Australia, helped keep risk appetite on the front foot and the USD on the back foot. While the market attention gravitates towards the EUR ahead of this week’s ECB we see the potential for GBP to outperform, and USD to underperform.
– Edited by Clare MacCarthy
Neil Staines is head of trading at The ECU Group