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Markets calm ahead of non-farms and Italian referendum

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Economists, it is said, use decimal points in their forecasts to prove they have a sense of humour. It must be a hoot to work at the OBR then, where the economists reckon Government borrowing will be £17.2 billion in 2021/22. In truth, one could probably safely deal on either side of a £15-20 billion price, or even £10-25 billion, such is the volume of water to go under the bridge between now and then. The point is that Chancellor Philip Hammond’s first (and last) Autumn Statement revealed that the Government will no longer be trying to balance the books during this parliament. This is sensible, as there is no point in sticking to austerity targets if this runs the risk of adversely affecting growth.
 
However, more than half of the forecast deterioration in the public finances, £58.6 billion, in fact, is down to the Brexit-related effects of lower immigration, weaker productivity and lower growth. Given the hysterical forecasts of immediate economic Armageddon ahead of the referendum, it is perhaps no surprise that markets took all of this in their stride. Hammond’s announcement of £23 billion on infrastructure spending is welcome, but this is to be spread over the next five years and represents just 1.2% of a single year’s GDP. To put this into context, Donald Trump’s promised trillion dollar infrastructure spend represents over 5.5% of US GDP. The most significant change in the Autumn Statement was that the Budget will now be in the autumn, with the statement in spring. Hence, next year, we shall have the delight of two budgets.
 
Meanwhile, pity poor Sir Kim Darroch, Her Majesty’s Ambassador to the USA. Having joined the Foreign Office straight after graduation, and achieved the top diplomatic post earlier this year, he now finds President-elect Trump openly mooting the prospect of Nigel Farage occupying that exalted position. At times it is something of a struggle to believe that this is actually real. That said, there is no doubt that Trump greatly appreciated the support of the on-and-off Ukip leader during his election campaign and, as Farage is apparently preparing to emigrate to the US anyway, closer contact with the famously tee-total Trump may complete a lifestyle change.
 
US markets continue to embrace the fiscal lassitude of Trumponomics, with elevated US stock markets and bond yields (although the 10-year yield is now some eight basis points off last week’s high of 2.41%). The US dollar too remains well-bid, with EUR/USD at 1.0590 and GBP/USD at 1.2400. In particular, Trump’s planned infrastructure splurge is attracting very little criticism. Some point out that, with the US economy in relatively fine fettle, there must be a risk that the stimulus will prove to be pro-cyclical and lead to inflation. Indeed that is the whole point. Although Trump has been vocally critical of the Fed’s policy of easy money, he will be perfectly happy for the FOMC to stay behind the curve and allow a little more inflation in order to chip away at the real value of the US national debt. For the time being, however, markets believe that above-target inflation will be met with a more rigorous response from the Fed – hence the strong dollar. When it dawns on market participants that it really is no different this time, and that history is about to repeat itself with another manifestation of the magical powers of inflation on debt, the turnaround in the dollar’s fortunes could be dramatic.
 
It is not just in the States that economic conditions are improving. The eurozone continues its steady, albeit unexciting improvement: both manufacturing and services' PMIs exceeded expectations last week. Even in Japan, which has flirted with deflation for decades, there has been a glimmer of hope as October’s CPI recorded a positive number (0.1% year-on-year, compared with September’s negative 0.5%) for the first time since February.
 
Despite the improving global economic situation, the world faces powerful political headwinds, not least in Europe. The Italian referendum on constitutional reform is looming this weekend, and polls released before the pre-vote poll black-out period showed ‘No’ to have a five to seven point lead. Prime Minister Matteo Renzi has promised to resign if he loses, and this would pave the way for M5S who have promised a referendum on continued membership of the euro. To this spicy political mix must be added the on-going Italian banking crisis, which is beginning to make a mockery of the stability tests which most banks passed with flying colours in the summer.
 
In short, Italy is as close as it has ever been to leaving the euro and Italy’s leaving would signal the end of the single currency as we know it. Freed of a major weak link, the euro would in all likelihood strengthen, putting even greater pressure on weaker members for whom the currency is still far too strong.
 
Also coming on Sunday is the re-run of the Austrian presidential election, where Glock-touting right-winger Norbert Hofer stands a good chance of election. This is something of a sideshow, however. If the Italian referendum is a ‘Yes’ and does not lead to a change of government, worsening of the banking crisis or worse, the next big European political event will be the French presidential election. After last weekend’s French primaries, Francois Fillon will take the fight to Marine le Pen in what will prove to be a nerve-wracking contest. While the Front National has often done well in the first round of the presidential election, in what has smacked of a protest vote, Le Pen’s performance in the second round will be expected to be much worse. Given the Brexit vote and US election, however, past experience is unlikely to convince markets that Le Pen is without a chance.
 
The most watched UK data this week will be the PMIs, with manufacturing and construction tomorrow (expected to be 54.4 and 52.2 respectively). We shall have to wait until next Monday for the more important services sector number. The most important data release, though, will be the US labour market data on Friday. Non-farm payrolls are expected to have risen by 180,000 in November, while the unemployment rate is expected to be unchanged at 4.9%.

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

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