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With markets recovering from the initial negative impact on sentiment of the Brexit referendum, participants last week turned their focus to the ECB and Fed and began fretting about interest rate policy. Last Thursday, ECB President Mario Draghi opined that although growth was somewhat lacklustre in the eurozone, this did not for the moment justify an extension of the QE programme beyond March next year, let alone further cuts to official interest rates. This disappointed the markets a little and lent some brief support to the euro. However, Draghi is being given the benefit of the doubt and is still being trusted to follow through on his ‘whatever it takes’ pledge to avoid outright deflation and bring inflation back to its ‘close to but below 2%’ target.
Of much more interest was the US. After the release of August’s unexciting labour market data 10 days ago and the ISM manufacturing index showing contraction in August, markets were just settling for the run into the presidential election, expecting this to be unencumbered by anything so inconvenient as a Fed rate hike. Then last Friday, markets reacted badly to the news that arch-dove and FOMC member, Lael Brainard, would be speaking to the Chicago Council on Global Affairs later today. Despite the fact that Brainard spoke shortly before both the March and June FOMC meetings and, true to dovish form, urged against an imminent hike on both occasions. The markets took the news badly, marking the probability of an interest rate hike on 21 September up to 30%, pushing the S&P down 2.45% on the day and shaving a cent off EUR/USD.
Autumn may, according to Keats, be the season of mellow fruitfulness but it is also the season of stock market crashes, crises and general foreboding. It is still more likely than not that the market’s reaction to news of the Brainard speech represents seasonal twitchiness as traders return to their desks and consider economic conditions anew, without the soothing influence of sunshine and free-flowing rosé. For all the worry about a September hike, the Fed does not like to surprise the markets and a September hike would be just that. What is more concerning is that markets are so concerned about one speech by one member of the FOMC that may or may not presage a 25 basis point rise in Fed funds. The worry is not that the Fed may raise rates, but that the market is apparently so anxious that it might.
The jitters demonstrate the markets’ ongoing addiction to ultra-low rates. The Fed will be keen to avoid a repeat of summer 2013 when the bond market threw its famous ‘taper tantrum’, sending 10 year yields over 100 basis points higher in a couple of months, as then Fed Chair Ben Bernanke mooted ‘tapering’ the QE programme. When the monthly bond purchases were tapered in December 2013, yields actually fell, but this was after a great deal of soothing rhetoric. Given last Friday’s reaction, it is difficult to see what the Fed would gain by hiking in September, particularly with an increasingly uncertain election in November.
On which subject, Hillary Clinton did herself no favours last Friday as she described half of Trump’s supporters as belonging to a ”basket of deplorables”, accusing them for good measure of every derogatory ‘ism’ under the sun. It is difficult to imagine anything that could have galvanised Trump’s campaign more successfully than this ludicrous gaffe, which is sadly reminiscent of Gordon Brown’s notorious ”just a bigoted woman” comment ahead of the May 2010 UK election, which he of course lost. Clinton has since apologised, but if she loses the election it will be her outburst on 9 September that many historians will cite as the deciding factor.
Over the weekend we learnt that Clinton is suffering from pneumonia, adding grist to Trump’s mill that she is not physically fit for the job of President. It is not known whether Trump’s well-publicised remarks on Clinton’s health over the last months have been based on some sort of leaked inside knowledge, or whether they have been mere conjecture in a very dirty campaign. However, they now have more than a grain of truth to them and America appears a step closer to electing Trump as President.
Financial markets are already nervous that the ECB and the Fed may no longer be pursuing policies that are virtually guaranteed to maintain the liquidity required to support bond and stock markets. To these worries we must now add shortening odds on a Trump victory. For the time being, markets are still not quite prepared to believe that Trump could occupy the White House. However, it seems highly likely that, whether or not he is victorious, at some time between now and 8 November, it will look like he might win, and that will be enough for some severe market reaction.
On the home front, this week will shed more light on the state of the post-referendum UK economy. The British Chamber of Commerce (BCC) this morning released new, lower growth forecasts for this year and next. Forecast growth for 2016 has been reduced from 2.2% to 1.8%. Although the BCC does not anticipate a recession, its forecast for next year is down from 2.3% to 1.0%. Accountancy firm BDO is also forecasting no recession. They currently see their business optimism index at 98.7, up from 97.9 in August, and on a scale that needs to dip as low as 95 to indicate recession on a six-month forward-looking basis.
The official data releases start tomorrow with the inflation numbers. CPI is expected to have moved up a notch to 0.7% year on year in August, while RPI is expected to have moved down a notch to 1.8%. Wednesday sees average earnings growth, which is expected to have fallen to 2.1% in the three months to July compared with the same period a year earlier – down from 2.4% for the same comparable to June. Unemployment is expected to have remained at 4.9%. Thursday sees retail sales which are expected to have risen 4.8% year on year (ex autos) in August, after July’s strong 5.4% rise. Also on Thursday, the MPC meet but no change is expected to either base rate or the QE programme.
All views expressed here are the author’s own and are based on information and data available at the time of writing.
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