Markets buffeted by political risk and economic realities
14 October 2016
Political mudslinging in the US presidential election campaign has had journalists around the world wondering how much lower the supposed stalwart nation of democracy could sink in the eyes of the world. Investment strategists, on the other hand, are conceding more and more often that political risks are now dominating their lists of potential threats to the global economy and thereby markets.
Against this backdrop, the macro and micro economic news flow of the past week has actually contributed much welcome evidence of further stabilisation despite the seemingly destabilising world of populism-driven politics. Decent but not soaring US jobs numbers suggest that the US central bank (Fed) will be safe to raise interest rates but there is no pressure to do so until after the presidential election, i.e. in December rather than November. This keeps Fed policy out of politics and de-risks the time period around election day. The minutes of the September meeting that where released last week contained similar hints about a steady but slow tightening path to the ones from 1 year ago, before the Fed raised rates for the first time - in December.
Back in the UK, the continued downward adjustment of Â£-Sterling to arguably a new historical all-time low triggered plenty of coverage. The broader public got their first glimpse of the upward price pressures the currency weakness introduces through Tesco's '˜Marmite' spat with Unilever, who tried to push through price hikes of 10% on the back of it. Together with a rising probability of Russia and Saudi Arabia agreeing oil price supporting production cuts, this makes the end of deflationary pressures for the UK a near certainty for 2017. If the global economy continues to expand at the recently attained rate, then this does not have to be bad news for the shorter term economic outlook for the UK. That is, unless business and capital markets came to the conclusion that the UK and EU leadership will produce a Brexit framework that robs the country of currently assumed future upside potential.
The continued decline of Â£-Sterling against the US$ - now over 20% - tells us that large parts of the international capital markets are increasingly seeing a '˜hard Brexit' with all its pains for the UK's long term trade position as an inevitability. I wonder whether they are once again failing to read political statements adequately for what they are: Propaganda to woo the electorate. The fact is that the UK Tory government has a very slim parliamentary majority which it may well want to extend by calling an early election next year. It is also true that the 2 political heavyweights of the remaining EU - France and Germany - are facing national leadership elections and are therefore very unlikely to concede to any British Brexit demands which their domestic opposition may be able to portray as weakness. Business may want to follow a softer agenda, but they are not the electorate, which as the Brexit vote showed sometimes has very different priorities. Conclusion:
I would therefore not be surprised if this constellation just leads to 12 months of unconstructive political posturing while we continue to operate under the status quo of the existing economic framework.
This means that there is little reason to expect Â£-Sterling to strengthen significantly from here and indeed depending on how '˜determined' politicians want to appear to be pushing through national interests, there may be additional downside to the value of the UK's currency. However, politicians will hopefully also begin to get the message that pushing for full sovereignty can quickly be shown limits by capital markets, particularly if the trust in a nation is eroded to a point where foreign investors balk at further financing that nations substantial current account deficit. The sell-off in UK gilts over the past week, which unhelpfully drove up the cost of capital for UK businesses should have been a useful lesson for any of the newbies in our new government about the consequences to the real economy of their messaging to potential voters.
While some of the potential long term effects of the current policy and currency dynamics may appear quite worrying, there may not be too much downside in the short term. As long as the UK's consumers retain their relatively upbeat outlook and businesses follow their stoic British attitude of '˜just get on with it', then the economic direction may still be more along the upward trajectory recorded over August and September. Otherwise there is an as of yet small possibility of a rapid descent into a stagflation slowdown, where the devaluation '˜sugar-high' turns into leg-chains that drive up interest rates and forces a reduction of demand and consumption for the sake of defending the value of the Pound. Only such drastic action could compensate if foreign investors became unwilling to continue to fund the UK's current account deficit or in lay-terms our habit of spending more than we have generated as a national economy.
Watch this space - we will keep you posted.