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What have we been up to


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Euro stays strong through interesting times

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Commodities (from the Latin commoditatem, “fitness, adaptation, convenience, advantage”) are tradable goods that market practitioners have standardised to increase all parties’ comfort in exchanging the product. If last year is anything to go by, realism is no commodity at all. The ’bad’ thing about realism is that most people perceive it as a dull nightmare (like a seventies’ concrete wall) from which to escape. Having to choose between fight and flight, a population of dreamers heads straight for the runway, with the consequence that demagogic storytelling is mistaken for good social policy. Yielding blindly to the former eventually leads the flight into that same concrete wall, when suddenly one is reminded to blink, hard.

The last few weeks have been ones in which this niche, poorly understood product of intellect traded by the bucketful: Italy is out of the football World Cup tournament for the first time in 60 years;  Venezuela has (at last) defaulted on its foreign debt; and negotiations surrounding the UK's secession from the EU are stalling and rough as ever.  In the same vein, it would be churlish not to mention the independence leaders in Cataluña and, lastly, there is a merry-go-round called the USA that continues to rotate, one tweet at a time. All these events and processes - and these are but a few -  have in common a large dose of populist propaganda (for the political ones, at least), a presumption of superiority in ideals or qualities, and ultimately a significant degree of superficiality, combined with very little humility in facing all-too-real socio-economic consequences.

Keeping a sense of perspective may help. One month ago Cataluña’s vote for independence was hot off the printing press, Trump had just started with his long-awaited fiscal reform, and Theresa May had only recently begun positioning the UK to ‘pay’ its divorce bill, or at least some €20bn of it. The shock was so great that some commentators were expecting a fall in the EUR, with the prospect of a ‘soft Brexit for a strong UK’ supporting the pound, and a US corporate rush to repatriate USD. At the time, I had to advise some UK and Italian clients that their hopes of taking advantage of a materially weaker euro were at risk of being dashed – as indeed I would most of the time to test anyone’s commitment to taking an opportunistic view on FX markets. We are in mid-November now and looking at a potentially strong year end for the EUR, and a weak GBP against both EUR and USD. So what has happened in the mean time?

The European Union – which is above all an economic union – is not suffering from the Cataluña v Spain boxing match, nor is it prepared to concede the privileges of its affiliates to the UK. All types of Catalan businesses, not just banks, left with the uncertainties of government, taxation and contractual positions, are moving out and establishing their HQs in the competing capital Madrid, or just across their regional border. Cataluña’s downbeat will become another Spanish region’s upbeat, and that is just about it for the time being. With all my personal doubts on the validity of the democratic exercise (after all, most of the pro-independence leaders are currently in jail) ’stability’ will be re-established on 21 December with regional elections. On monetary rates, the ECB has laid out a very straightforward plan: negative policy rates will remain in place for as long as the ECB is fully reinvesting its QE stock, and after ending its outright expansion in September 2018. Depending on your view, this will be some time between mid-2019 and early 2020. I do not buy completely the idea that rates will be at current levels well into 2020, and the main reasons are that a) Draghi’s mandate will end in November 2019, and b) inflation will have a chance to pick up during the next two years for both political and economic reasons.

So, euro strength comes from both rational and emotional stability. On the rational side, the EU economy is strong: it continues to grow ‘fast’ – it could be growing faster than the US for the second consecutive year in a row, – and employment continues to improve. On the emotional side, the EU is a slow bureaucratic economic area, and is more reliable by comparison with other countries whose delusional governments take longer than necessary to close in on reality. The euro has regained, at least for a short period, the status of a currency in which one can comfortably park cash and investment hopes. Some have alternatively chosen bitcoins, and I can only wish them good luck for the ride.

This is very much a relative position, not at all one of absolute strength, but what is there on the other side?

In the US, Congress is watering down Trump’s grand fiscal reform, and some key components are being postponed to 2019. Moreover – and in reality rather than on Twitter - Trump continues to show that he has not just cufflinks, but golden handcuffs on his wrists. For good or ill, most of the results he plans to achieve are looking like they will arrive just as slowly as those obtained by the previous president, if at all. It has been less relevant to the financial markets that the new Fed Chair, Jerome Powell, is likely to continue with his predecessor’s plans on quantitative easing and monetary policy: yield curves incorporated this outcome already, so changed little on the day of his nomination. We will discover if this was correct at the FOMC meeting on 13 December, for which a full 25bp hike is priced in. Looking forward, the OIS yield curve has a further hike priced in by March 2018, with a possible third one to follow in H2 2018. Should they happen, these hikes would not affect FX rates, as only a proper fiscal reform would move the needle materially for USD.

Similarly, in the UK nothing is progressing smoothly. With regard to Brexit negotiations, UK proposals are late to the EU table, and continue to be clouded at best. Moreover, internecine succession wars within the Tory party are forcing May to waste energies in the role of ringmaster, juggling with lions, snakes and jesters, instead of focusing on being the Prime Minister. This obviously weakens the UK’s stance in the negotiations, and further delays between now and March 2018 would allow for the chance of ‘no deal’ by 29 March 2019 at 11pm. This is why, as spot rates incorporate all the foggy future, there is no relief for sterling exchange rates. It is also why there is a widespread perception that ‘no deal’, without any transition period, is a real possibility to attend to, with the distraction of resources and investment focus that this could portend.

Incidentally, Italy being out of the World Cup is a great outcome for the World Cup itself, and for Italian football. As it happens, having four stars on our Maglia Azzurra is no guarantee of success. Success, professionally speaking, arrives when you fight for it with realistic expectations. It is fine to be daydreaming about the world cup of your life, but sooner or later you will have to wake up and work hard for it.

All views expressed here are the author’s own and are based on information available at the time of writing.



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