Weekly Brief

Tough times ahead

13 minute read

18 November 2022


The much-anticipated Autumn budget statement, announced by UK chancellor Jeremy Hunt yesterday (Thursday), delivered a substantial package of tax rises combined with spending cuts, that at £55bn, seek to reverse the shambolic ‘mini’ budget tax cuts and unfunded spending plans, orchestrated by his predecessor Kwasi Kwarteng just eight weeks ago. The package has also been designed with the aim to tax those who can afford it more, with an increased tax on energy companies, with their windfall taxes on profits rising from 25 to 35%, and the point at which higher income earners get taxed has been lowered from £150k to £125,140.

Energy bills set to rise

As expected, the help with energy bills scheme will now be scrapped for all from next April, which is set to see a typical energy bill rise from around £2,500 to £3,000 per year, although in reality, many typical consumers will have been paying far more for their energy supplies, even before the government changes come into consideration. However, extra payments will be coming for those on benefits, pensioners and disability benefits.

A shorter recession

Interestingly enough, many of the increases in taxes will not kick-in until after the next election, although that may just have been a complete coincidence. The office of Budget Responsibility (OBR) also suggested that the planned tax rises and spending cuts should ensure that the UK recession is far shorter. Given the fact that the UK is currently paying more in interest charges on existing debt, than on any public service bar the NHS, the need for a re-think, albeit at a time when the cost-of-living increases is already making it tough for so many, has been clearly evident. This is especially so, given that surging inflation, at over 11%, will ensure that the BoE will need to consider further rate hikes, even if the UK is now already in a recession, according to the good people at the OBR.

Sterling slips

The pound slipped on the session, but the market reaction has been fairly positive, when balanced against the apocalyptic reaction from the last version delivered by the previous chancellor Kwarteng. GBP/USD slipped from a high of around 1.1958 to under 1.1765, however, much of that move can be attributed to a broader risk-off session across the board, with the dollar finding some intra-day strength. Indeed, by Friday morning, GBP/USD was back over 1.1900 again. GBP/EUR drifted from around 1.1460, to 1.1400, before bouncing too.

Thoughts from the dealing desk

“The most important informational release yesterday was the Autumn Statement from the ‘new’ Tory Leadership. Jeremy Hunt, Chancellor of the Exchequer and fellow Old Carthusian announced a slew of tax rises and spending cuts worth billions, in an attempt to tackle the soaring inflation issue and to try and restore the UK’s credibility with international markets, in what can be considered a highly austere autumn budget. The Office for Budget Responsibility judges UK to be in recession, the OBR predicts growth for this year overall of 4.2%, but size of the economy will shrink by 1.4% in 2023. Growth of 1.3% predicted for 2024, 2.6% for 2025, and 2.7% for 2026, UK's inflation rate predicted to be 9.1% this year and 7.4% next year. Unemployment expected to rise from 3.6% to 4.9% in 2024. GBP/USD took a turn lower yesterday morning following what has been a very positive week for the Pound, since the release of softer US inflation data last week. The Pound had gained over 5% against the Dollar over the past week, breaking into the 1.200’s on a thin wick. The austere autumn budget sent the pound lower against the USD by over 1% as tax increases and spending cuts were absorbed by the wider market. Many clients had feared the budget may send the Pound lower and looked at covering USD exposure prior to the budget. With the pound falling yesterday morning, last minute hedges were put in place to protect against the anticipated downside movement on GBP/USD & to take advantage of the recent rally for cable. Clients whom acted early yesterday managed to mitigate most of the losses for GBP ahead of the budget. ”

-Oliver Taylor, FX Dealer


Mixed signals

Having bounced from around 0.9750 to just under 1.0400 from the beginning of November to the end of last week, this week has been fairly flat for EUR/USD, with the single currency maintaining those gains, without pressing forward. Mixed messages have played their part, with rumours of a split amongst the ECB as to whether they should continue raising Euro area rates at 75bps going forward, or adopt a smaller pace of hikes. Economic data has also played its part, on the one hand, slightly softer regional headline (Harmonized) yearly inflation of 10.6%, versus an expectation of 10.7% could be considered a positive, however, weaker regional employment gains, soft growth, and tepid manufacturing data, also suggest that the economic slowdown is accelerating.

Weaker PMIs to come?

Further evidence of the slowdown could come in the shape of next weeks region-wide PMI reports, which are likely to slip further into the mid 40‘s across the region. Remember, anything below 50 is considered as an economy that is contracting. That is likely to be followed by weakness in the latest German IFO survey, as the impact of high inflation and surging prices damages the current outlook and immediate future prospects.

A crossroads for the single currency

The single currency is therefore at a bit of a crossroads. EUR/USD may have briefly achieved a new cycle top at 1.0480 earlier in the week, however, markets remain cautious about the prospects for the ECB to continue to be able to deliver bold rate hikes, against that weakening backdrop. It may therefore take relative US dollar weakness, or more concrete signs of weakening inflation in the region to inspire further gains in the single currency, or face the likelihood of an extended period whipsawing around the parity region.


Softening inflation

After last week’s strong rally in risk assets driven by the weaker US CPI report, the rally was further cemented in the early part of this week, after the latest US PPI report also highlighted the emergence of potentially softening prices. The PPI index for final demand rose 0.2% (MoM/Oct), and way below estimates of around 0.5%, helping to ensure that the yearly headline reading dipped to 8%, from 8.4% previously. Core PPI dropped from 7.1 to 6.7% (YoY). Markers rejoiced (again).

Fed to slow the pace?

Whilst the combined inflation reports certainly played their part in ensuring that the strong rally in risk assets continued, the move has also been helped by several Fed speakers, who have suggested that, data depending, the Fed might consider a slower pace of rate hikes, as early as next month’s FOMC meeting. Both Fed chair Powell, and deputy Brainard, have said as much over the past couple of weeks. Markets have been quick to re-price expectations for the December meeting, which has now decreased from 75bps to 50bps.

Caution is warranted

Notwithstanding the softer inflation and Fed speakers, not all US data is reflecting a material slowdown, with the latest Retail Sales data showing a hearty 1.3% (MoM/Oct) increase, and perhaps highlighting that US consumers are still out there shopping in their droves, despite those big interest rate rises, and higher inflation causing a big squeeze on incomes. Indeed, and perhaps to balance the earlier comments from the likes of Brainard, the Fed’s Bullard was quick to comment that the policy rate is not ‘sufficiently restrictive’ and that rates would be in the area between 5 and 7%. Bullard has been particularly bullish on US rates for as long as we can remember, so we should perhaps not take his comments as a fair reflection of all Fed members. Furthermore, given that there is another employment and inflation report both set for release ahead of the next FOMC, markets should also not get too far ahead of themselves.

Not a great time to be a dollar bull

The dollar decline that began after the dollar index (DXY) peaked at 114.70 in the last week of September, continued until the middle of this week, reaching a low of 104.90. Looking ahead, it is probably also reasonable to suggest that, unless there is a material event for markets to go into a nosedive, the high for the dollar this cycle has probably been reached. Amongst the major currency pairs, USD/JPY has now moved from around 152.00, to under 140.00 in that time, and most of that move happening well after the BoJ last intervened. Impressive indeed.  Next week is all about the US Housing market, with further declines highly likely given those rate hikes, and evidence of previous declines.


Softening inflation (V2)

Much the same as in the US, there have been some emerging signs of softening inflation in Canada after the latest report was released earlier this week. Whilst the annual rate of headline inflation remained steady at 6.9%, a worthy drop in the yearly core reading from 6 to 5.8%, raised more than a few eyebrows.

Food is cheaper, but avoid driving to get it

Analysts had been expecting headline monthly CPI to accelerate after gas prices rose in October, and they were correct, with the 0.7% increase bang in-line with expectations. However, the big increases in gas prices were somewhat offset by a slowing price growth for food. Despite the good news on the food front, one month’s worth of data does not maketh a trend, and a cautious approach is still warranted. Indeed, whilst the Bank of Canada did not comment on the recent inflation report, previous comments suggest that they will sensibly want to see more evidence before they feel comfortable enough to halt hiking rates.  

Will Retail Sales slow?

On that note, analysts are expecting to see a marked decline in Retail Sales activity, when the latest report is published next week, highlighting a cautious Canadian consumer. As for the Loonie, well USD/CAD has turned northward after declining from 1.3800 to just over 1.3200, which is broadly in-line with greenback weakness elsewhere.


A robust Australian Labour report

The latest employment report will leave the RBA with much to consider. With a snappy 32.2K gains on the headline more than doubling estimates, coupled with a near-record Labour force participation rate of 66.5%, and a dip in the overall unemployment rate to 3.4%, the RBA will come under further pressures to hike rates in Australia, as the robust labour market suggests unexpected strength in the economy.

RBA minutes

The minutes from the last RBA meeting highlighted that the RBA came very close to raising Australian rates by 0.5% last month, before settling on a 0.25% move. With inflation still running at a 30-year high, the jury is still out on the RBA’s next move. Indeed, they have said as much themselves, suggesting that interest rates are not on a pre-set path.

RBNZ to go with a bold hike?

It is a big week for New Zealand next week, with the next RBNZ decision, as well as key Retail Sales data. On the rates front, and also given surging inflation, some analysts are calling for a super-sized 75bps move – which would take New Zealand rates up to a giddy 4.25%, were the RBNZ follow through. As for AUD/USD and NZD/USD, both currencies have turned south over the past couple of days, after reaching new cycle highs earlier in the week. AUD/USD topped-out near 0.6800, with NZD/USD reaching 0.6200.


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