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TWO WEEKS – EVERYTHING (AND NOTHING) WILL CHANGE

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We now find ourselves at the eye of the storm, so to speak. Last week was littered with key market events in the UK and Europe, and then there’s the ongoing US Presidential pandemonium which concludes this week.
 
We never live too far from Brexit these days in the UK, and this was never truer than it was last week. On Thursday the High Court ruled that Parliament must be allowed to rule on when and whether to trigger Article 50, which would start the official process to leave the EU.
 
There has been a sizeable backlash on this result, ironically because a contingent of the population believes it to be antidemocratic to allow elected Parliament to vote on this. Belief that this is an establishment ‘stitch-up’ is rife countrywide, and not really helped by the fact that the woman who brought the case is a hedge fund manager.
 
In a democratic state, whether or not Parliament votes on this should make no difference; the rules of the Referendum were simple - vote out and our elected representatives will make it happen. The fact that so many believe that politicians will use this as an opportunity not to do this strikes at the heart of why people voted Leave in the first place: a lack of trust in the system. While these people are overreacting, with Brexit now a foregone conclusion (the idea that our democracy is broken being too horrific to contemplate), financial market participants (or at least forex traders) clearly disagree. Immediately following the ruling, GBP/USD strengthened by a good cent. An interesting poll was released last week that asked where those who voted Remain stood on the stages of grief with regard to the referendum. Unbelievably, over 40% selected “denial,” rising to over 70% in London. Upon seeing this you can understand why markets keep reacting so positively on decisions such as this made by the High Court.
 
Just hours before all of this, we were privy to another Super Thursday as the Bank of England released its quarterly inflation report and the MPC meeting notes at the same time, shortly followed by a press conference with Mark Carney. It was no shock that the committee had decided unanimously to keep rates at the target 0.25% this month. What was more surprising was that due to the recent data it is no longer expected that they will vote to cut rates in December. Furthermore, there was a number of surprisingly positive notes to come from the report. Most notable was an upwards revision of GDP for this year by 0.7% and an almost doubling of the Bank’s estimate of next year's growth to 1.4%, reversing the substantial cuts made to these estimates in August’s report.
 
In contrast to this, there was a downward revision for 2018 and beyond. The subtleties of forecasting come into play at this point. Carney admitted that the same model as was used for August has been employed for the longer-term outcome in this report. As already stated, this model led to a large cut to the GDP projections for the last report. The press conference delved in detail into how and why this occurs, but the main point is that we should expect more of these large revisions to near-term expectations. As a point in time gets closer, the Bank shifts away from economic theory-based models to more data-based ones, which of course makes them more accurate. That is why contradictory pictures are emerging: the long-term is still being predicted by theory based models, but the near-term is based on recent data which has defied all expectations of a downturn. When the forecasts for 2018 are affected by the same shift from theory to data-driven models, there could be a similar outcome.
 
The problem, as has been freely admitted by the Bank of England, is that due to the lack of information on what the UK's wider economic position will be in 2018, modelling is nearly impossible in any format. They are currently using a weighted average of various scenarios - though what these scenarios are, and how the Bank has weighted their likelihood, was not disclosed.

Moving to the US; in the first half of last week markets grappled with the implications for the US election of the FBI’s re-opening of the investigation into Hillary Clinton’s email server. Interestingly, despite 30% of voters declaring that this would make them less likely to vote for Clinton, the betting odds moved only very slightly with Trump still the 5/2 outsider. The US stock market was more concerned, however, by the apparent increased probability of a Trump victory, and traded poorly all week, as did the dollar. While the stock market move makes sense, the implication that a Trump victory would be bad for the dollar is harder to agree with. Many readers will remember the global financial crisis, which peaked in autumn 2008 with the collapse of Lehman Bros. Over the next desperate months, as central banks slashed official rates and QE began, the US stock market and the dollar reacted positively to bad news. Bad news meant a better chance of more stimulus, boosting the stock market, while that same news tended to cause investors to view the US and its currency as a safe haven compared with elsewhere.
 
Should Trump become President and attempt to bring jobs back to the US by imposing tariffs such as his mooted 45% on imports from China, there would be the clear danger of a trade war. The US is the least open of all the developed economies and this non-reliance on trade would put it at a huge advantage in such a depressing scenario compared with trade-dependent countries such as Japan, Germany and the UK. These countries have much more to lose from a change in the status quo, and their currencies are consequently more vulnerable to a Trump victory. That said, such an outcome became less likely overnight as the FBI exonerated Hillary Clinton and Trump’s odds have drifted to 9/2

This week is fairly light on economic data. Tuesday morning has UK manufacturing and industrial production figures, and the expectation is that there will be a moderate increase to both - probably reflecting increased orders from the beneficial currency movement for exporters.

As you arrive at your desk on Wednesday morning news stations will likely be reporting who the next President of the United States will be. Expect turbulent market activity all week, but hitting its climax then.

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