Recent months of daily Brexit drama in parliament caused significant volatility in FX markets as they tried to assess the likelihood of an imminent no-deal exit from the EU. With the general election now scheduled for 12th December and the Government accepting the offer of an extension until the end of January this possibility has receded. Sterling saw a strong finish to October as a result, and overall on the month it outperformed its major rivals by a comfortable margin.
Market expectations currently factor in that opinion polls are generally forecasting the Conservatives to win an outright majority in December. A Conservative victory would provide Boris Johnson with his mandate to ‘get Brexit done’. The deal negotiated in October with the EU could then be delivered with support from parliament.
It may be wrong however to see this as a period of stability for Sterling. This is widely considered to be one of the most unpredictable elections in a generation, and recent history suggests that the polls need to be treated with caution. At the snap General Election in 2017, Theresa May saw her strong lead rapidly evaporate and the Conservatives lose their majority in Parliament.
The Conservative and Labour leaders can each have a polarising reaction on voters. The parties will try to focus on their domestic agenda but turnout may have an impact in an unusual winter election, and where there has already been a surge of new, mostly young, voter registrations. Voters will also view parties in relation to their own passionate views surrounding Brexit, austerity, Scottish independence and the NHS. The Brexit Party and the resurgent SNP and Liberal Democrats may attract voters and fragment the dominance of the two main parties.
Although Sterling daily volatility over this period is likely to be lower than we have seen recently the ebb and flow of general election campaigning is likely to create fluctuations through November and early December.
US-China Trade Wars
Brexit is not the dominant factor for international markets although it takes much of the domestic headlines.
The US is the world’s largest importer and China the world’s largest exporter. The US & China traded $737.1 billion in goods and services in 2018 – a higher figure than UK trade with the whole of Europe.
The continued trade war between the two shows no sign of cooling down. President Trump began setting tariffs and other trade barriers on China starting in 2017 with aim of forcing them to amend what the U.S. claims are unfair trade practices. China retaliated with their own tariffs in 2018 and there was escalating tension and widening tariffs on both sides up to the summer of 2019.
The Chinese Yuan has weakened significantly against the Dollar; increasing tensions. The US Treasury assessed this is a deliberate act of manipulation after it fell below 7 Yuan to the dollar in August 2019. Although there is limited transparency in Yuan market interventions by China’s central bank, the International Monetary Fund disagreed with the designation, arguing that the Yuan’s value was in line with China’s fundamentals.
Reducing the trade deficit and promoting domestic manufacturing, was a major part of Trump’s populist “Make America Great Again” campaign. The policy has been controversial because few economists identify the trade deficit as a significant problem, and fewer still that tariffs are the solution to it.
In the United States, the trade war has brought struggles for farmers and manufacturers and higher prices for consumers. In other countries it has also caused economic damage, though some countries have benefited from increased manufacturing to fill the gaps. It has also led to stock market instability.
We do not expect a dramatic improvement or changes in the mostly negative outlook for the trade talks that are still ongoing. Although the two sides are maintaining a dialogue the situation remains tense; with limited expectations of a breakthrough. Recently there has been a transition to a much more phased approach to reaching a trade agreement – although achieving the limited phase 1 agreement is possible before the end of the year it remains unlikely according to analysts.
Trump & US Interest Rates
In a stable and healthy economy, gradual interest rate hikes are generally viewed as a positive move by a central bank. Higher interest rates also bode well for a country’s currency as they attract more foreign investment, therefore increasing a demand for that currency.
In the aftermath of the financial crisis the Federal Reserve led the way in hiking rates. From December 2015 over three years the US interest rate rose from 0.25% to 2.5%. In 2019 however the US central bank has been cutting rates, with three reductions.
The latest reduction at the end of October lowered interest rates by 25 basis points to a target range of 1.5% to 1.75%. There is speculation that there may be another cut before the year is out.
The move followed news that the world’s biggest economy grew at an annual rate of just under 2% in the third quarter of 2019.
The president has put intense pressure on the Fed to boost the US economy and his own re-election prospects by making aggressive cuts to the cost of borrowing.
The chair of the central bank has said there is a limit to what the Fed could do and that a more effective way to stimulate activity would be for Congress to loosen fiscal policy through spending increases or tax cuts. Despite this many analysts believe that facing further deterioration in the economics data the Fed will cut interest rates again in December. Growth has slowed this year as the impact of tax cuts has faded and manufacturing has been hit by the trade war with China.
Trump remains combative in his desire for low interest rates (or even negative ones) and his distain for the Fed. He has boasted about the strength of the economy but feels that a strong dollar hinders the US performance in global markets by making US exports more expensive.
The Eurozone has been struggling to show any positive signs of significant growth in recent times.
Third quarter GDP in the Eurozone showed 0.2% quarter on quarter. This helped the Euro to stabilise as it was similar to the previous quarter; and slightly stronger than the 0.1% financial markets had been expecting. The data suggests that Germany may have avoided slipping into recession in the third quarter.
The eurozone’s annual growth rate has continued to decline during 2019. The 0.2% growth rate along with poor survey data and higher unemployment makes it seem unlikely that there will be any dramatic recovery soon.
The trade war between the US and China has impacted the Eurozone, however there is a possibility of a developing US & Europe trade war increasing in intensity. The WTO have given the go-ahead to retaliatory tariffs on USD7.5 billion in European exports as a result of government aid to Airbus, and will rule early in 2020 whether similar subsidies to Boeing in the US were also illegal.
Trump has already imposed tariffs of 25 per cent on European steel and aluminium and may decide shortly to add duties on cars, which are one of the EU’s most important industries. Economic damage would not however be limited to Europe as American exports to Europe are over 3 times that to China meaning it may be American multinational companies that would be the hardest hit in the event of escalation.
While you can’t control the exchange rate, you can manage the risks of international trade and currency payments. Talk to Central FX for expert advice and for help to plan ahead.