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What have we been up to


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Markets face the prospect of a tricky year ahead

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The political surprises of 2016, and the potential for there to be more on the way in 2017, have certainly given the markets plenty to think about – even if the economic consequences of these events are very uncertain for both fiscal and monetary policy.

On a very basic level, the elevation of Donald Trump to President-elect should produce a fairly straightforward outcome, as his policy statements grew very repetitive during the election campaign. The incoming administration is going to have to go some way to meet the expectations of the sudden and unexpected surge of support he received in the run-up to the election. Fiscal action is suddenly set for take off. Much increased spending on infrastructure projects, protection of obsolete rustbelt industries, and the reining back in of free trade agreements are all going to boost government spending and there seems little in the way of increased taxation in sight to offset a rapidly increasing budget deficit. Nor are any savings with even the scrapping of Obamacare, in whole or in part, able to make much of a dent in the higher spending level.

In light of a much more active fiscal policy, it is hardly surprising to find Janet Yellen and the FOMC expounding a much less lax monetary policy for next year. Having increased rates last month, the Fed also projected that there might be a further three hikes during 2017 - although most market commentators have decided that two hikes will be quite enough. However, the outlook for a further reduction in unemployment looks good, as does the chance of inflation continuing to inch upwards. One thing is certain: it is very difficult to point to many aspects of the global economy that are likely to be anything other than positive for the US dollar.

If the background to what a Trump administration might bring about appears quite obvious, even if it is likely to prove arduous in finding its way through Congress and the House of Representatives, the outlook in the UK is much less clear. This is thanks to the enormous cloud hanging over the economy (and almost everything else for that matter) named Brexit. This is not going to change any time soon. Some announcement from the Prime Minister, giving the bare bones of what the UK is going to adopt as a negotiating stance once they have exercised Section 52 in a couple of months’ time, will be most welcome.

The UK media spend a remarkable amount of time forecasting what the UK’s exit strategy is, or what it should be, or if there even is one at all. In contrast, nobody seems interested in what the EU’s negotiating stance will be. We suspect that this will be dominated by the answer to the question – how much? It would seem to me that the one thing the EU will not accept is the failure of the UK to pay its share of the EU’s liabilities. Unfortunately, due in no short measure to the EU’s lamentable inability to complete a satisfactory audit process, nobody knows what its total liabilities are – hardly a satisfactory way to start any negotiations! However, while UK commentators can spend worthless hours arguing about what within Brexit can be changed to being less ‘hard’ or ‘soft’, the answer is that if we can negotiate the headline price in a relatively relaxed manner, the ability to curb the more restrictive or expensive parts of the Brexit process is likely to be much enhanced.

The fact is that we will probably not know much more about what Brexit really means in a year’s time than we do today. Away from Brexit - we do know that the May government is trying to go down a rather different road from her predecessor, and that this is likely to be a much more interventionist administration. While this is likely to be aimed primarily at social issues, it will also see the publication of Greg Clark’s paper on Business, Energy and Industry. This is a much-awaited paper, having been the basis, so we are told, for Nissan not only to continue with the current Sunderland factory, but also to develop a new production line dedicated to the production of their new driverless car.

Quite apart from the ‘advantages’ from which companies operating in Mr Clark’s chosen sectors will benefit, the proposed policy is likely to come under fire from excluded sectors. One company already causing considerable criticism of Mr Clark is the Green Investment Bank (GIB). While GIB has been in existence for only about five years, it has already gained a strong reputation for supporting UK investment in a key sector as well as being very profitable. Rather than treating it as a company to nurture, Mr Clark has decided that a quick sale to Australian investment house Macquarie - most inaccurately described as an Australian asset stripper - is a preferable result. Axing this notable success having nothing to do with it being the creation of Vince Cable, then! 

Economic growth this year looks as if it will come out at above 2.0% - a level regarded as being totally unrealistic at the time of the Brexit vote. The economy’s continued growth at a faster rate than expected has had the forecasters busily increasing their forecasts for next year – albeit not to this year’s level. Rising inflation combined with little upward movement in pay levels, to say nothing of record unsecured borrowing levels, are likely to push down on consumers’ ability to spend resulting in GDP growth next year of 1.4%. Meanwhile, assisted by a further weakening of the pound against USD, we see the CPI measure of inflation reaching 3.0% next year. As far as they are able, Mark Carney and his supporters on the MPC will try to keep short-term rates at current levels and they have already announced that they are happy to ‘look through’ a period where the targeted measure is excessive. However, the markets may not be so lenient and Carney may be forced back to more conventional monetary policy. We would regard the removal of the ‘helicopter’ aspects to the current QE programme as the most likely areas to address, although we would be far from surprised if short-term rates were to rise before the year is out.  

The GBP yield curve, however, while it has steepened recently, is still remarkably flat and offers very little protection against anything going wrong. Not only are US short-term rates expected to rise, the five-year swap rate in the US is also already only fractionally below 2%, whereas the UK equivalent is more than 1% lower. Not difficult to see why the normally very low-risk Rathbone family savings now include a USD money market account.

The year gets off to a slow start in the UK in terms of new economic news, with only the trade and latest industrial production figures (both out on Wednesday) to peruse. The industrial production figures should show a very strong result, as they should reflect a bounce back from the previous month’s very poor result.                                        




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