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Sterling Euro Transformations

Discussion and Analysis by Charles Porter:




As pessimism continues to surround the UK political economy with consistently positive macroeconomic results being published within the Eurozone, dominant market trends will be difficult to arrest. With this message mind, this article analyses the propensity of events and data releases to manipulate the Sterling-to-Euro (GBPEUR) exchange rate.


Member of the Monetary Policy Committee at the Bank of England, Michael Saunders, spoke in the city of Cardiff this morning. Breaking this week’s trend of deliberately negligent central bank speeches, Saunders did acknowledge the influence that a weak sterling, strong euro, will have upon future monetary policy decisions. Notably, Michael Saunders was one of two Committee members who voted on the 2nd August this year to increase the Bank (interest) Rate immediately from its current rate of 0.25% to 0.50%.


The summary of Saunders’ speech takes a pessimistic tone. The defence of his recent Committee votes relies upon an analytical judgement-call based upon economic spare capacity and inflation. The justification also affords a valuable, yet concerning, appraisal of the Brexit process. Described as “bumpy”, Saunders speaks of the propensity for the secession process to “undermine business and consumer confidence”. Whilst this speech had no tangible effect upon the GBPEUR rate, the logic behind the voting division within the Committee may influence future decisions.


The effect that this admonition can have upon the GBPEUR interest rate is exacerbated by Eurozone performance and survey results. Eurozone inflation rates released this morning, measured by the Consumer Price Index, reveal that both Core and Aggregate inflation year-on-year estimates have exceeded expectations. This change, that was foreseen by our analysts but overlooked by dominant market expectations, may lead markets to revise forward their anticipations of a curtailment of the exceptionally loose monetary policy within the Eurozone. This can take the form of either an interest rate hike or, most likely, a tapering of the Quantitative Easing purchasing programme.


In conjunction with a lack of comment by the ECB president, Mario Draghi, about the need to correct a strong Euro, the GBPEUR exchange rate seems unconstrained to fall. This lack of comment was observed upon two occasions; at the Jackson Hole symposium and Lindau Nobel Laureate Meeting. Moreover, recent Purchasing Managers Index show optimism within the Eurozone, and particularly the German, economy. All of these trends will be closely analysed whilst we await a meeting of the Governing Council of the ECB to discuss monetary policy in Frankfurt, one week from today.


However, pessimism within the UK economy may not be as long-lived as it currently seems. With Prime Minister May currently in Japan meeting with her counter part, Prime Minister Shinzo Abe, the propensity for post-Brexit optimism to be successful fostered is visible. Any optimistic news arising from May’s trip, however, is unlikely to surmount the incumbent market dynamics so long as investor and public perceptions of the Brexit negotiations are characterised by incoherence and stagnation.


Despite focusing upon the GBPEUR exchange rate, it is also worth noting that US macroeconomic indicator data-releases have been extremely positive. U.S consumer confidence has threatened post-millennium highs and yesterday’s second reading of annualised second quarter GDP growth showed dramatic increases to reach 3.0%. Therefore, similar dynamics within the GBPUSD exchange rate may be visible. Further analysis will follow today projecting the Eurozone adherence to a Phillips curve following inflation and unemployment statistics releases over the last 48 hours.



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Forthcoming US GDP Revision

Discussion and Analysis by Charles Porter


Economic Growth in the United States of America, measured by the annualised growth of Gross Domestic Product (GDP), in the second quarter of 2017 was 2.6%. This headline figure, published last month, was an ‘advance estimate’ and will be revised within a second estimate this afternoon. This article covers what is expected by foreign exchange markets and why this release matters.


The release of US GDP advance estimates, alike all nations, comes with an admonition of inaccuracy. In order to provide an indication of macroeconomic performance, statistics agencies use a predefined set of more temporally responsive indicators for indicative purposes. They are, therefore, “incomplete or subject to further revision”.


The Bureau of Economic Analysis correctly identifies that annualised second quarter growth, which was significantly higher than the first quarter revised estimation, was driven by consumption expenditure, export markets and government expenditure. This trend of consumption is in conformity with, and arguably caused by, the “second highest consumer confidence [level] since late 2000” (Bloomberg 2017). The Consumer confidence survey, released yesterday, showed that US consumer confidence has reached 122.9 index points, beating estimates and the previous month’s figure.


               Why does this release matter?


A recurring theme in our analysis articles this week has been macroeconomic and political uncertainty surrounding major international currencies. Within the US political economy, an epicentre of these concerns, the Dollar has made losses against other currencies, particularly the Euro which rose above 1.20USD yesterday. The decline of the dollar has been gradual yet pervasive. Therefore, a greater than expected positive economic growth estimate would support a reversal of US Dollar losses.


Moreover, as investors begin to proclaim the curtailment of risk-off movements, which generated the disfavour that the dollar has experienced, positive macroeconomic performance should encourage a stronger dollar. This US-focussed analysis, however, is deliberately ignorant of the Euro’s strength and expected path.


Finally, this release comes as expectations heighten around Trump’s imminent proclamation and clarification on his tax and trade policies. Some investors even see the market reacting to the realisation that the internalisation and pricing of assets and equities, that included expectations of Trump’s proposals, was premature. Surely, a positive economic performance statistic would be a good backdrop to launch this proposal.


               What is expected from this release?


Although only a modest revision is anticipated, it remains an upward revision. Therefore, with respect to the advance estimate, the second estimate is supposed to attest to moderately higher growth. However, the propensity for the revision to show a bigger change is clear, with the precedent being well established by previous GDP estimations.


The average revision of GDP national accounting within US releases, from advance-to-second estimation, is 0.5%. This is the average change observed between 1993 and 2014. Therefore, given the importance of this release, shown within the previous section, and a proven capacity for more perceptible change, this GDP result release should be watched carefully as it may exceed expectations.



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The day ahead for major currency pairs

Discussion and Analysis by Charles Porter:


In accordance with our week ahead expectations, today and tomorrow will be another testing and opaque period for major currency pairs. Today’s events will be followed closely because each contains the propensity to arrest or enhance the current trend of a strong Euro, a weak dollar and a week pound that have characterised the recent period.


Whilst the current mechanisms behind these currency trends can be simplified into two strands, macroeconomic versus political uncertainties, only the former is likely to be influenced by today’s announcements. It is plausible, however, that by the end of the week, the political uncertainty that affects Pound Sterling and US Dollar currency pairs will be reduced. This is possible because once Prime Minister Theresa May’s visit to Japan is concluded and further information on President Trump’s tax reform intentions are announced, political commitment as well as future economic certainty will be created.


Immediately, the macroeconomic events that will be watched closely are the Spanish flash estimate of the Consumer Price Index (CPI) and a similar publication of the German inflation rate. These two events should attract increased attention due to their ability to forebode and contextualise the Eurozone-wide inflation results release that is scheduled for tomorrow. This attribute of today’s inflation index data therefore makes it likely that market volatility and reactiveness will be exacerbated by any unanticipated changes.


As the largest economy by Gross Domestic Product within the Eurozone, Germany’s CPI figure will attract relatively more attention due to its concomitant influence upon tomorrow’s aggregate Eurozone inflation rate. Inflation is especially important to exchange rates as an indicator of the macroeconomy and its correlation to the business cycle. It therefore serves as a gauge of the need for fiscal and monetary retraction or stimulus. Especially within the current market, it will be interpreted as a qualification of the anticipated tapering or ending of Quantitative Easing (QE) and any impending interest rate hike.


However, Eurozone inflation is even more important than this. Today, rhetoric has once again surrounded the Euro as a suboptimal currency area. Therefore, unlike any other unified or national currency, the disparity of Eurozone member states’ inflation rates is arguably just as important as aggregate Eurozone inflation. Suboptimal currency area studies can be proxied as the cost of a monetary union. The cost of a monetary union is associated with the loss of national monetary instruments and, by corollary, a commitment to a one-size-fits-all, union-size-fits-all, monetary policy.


Therefore, disparate inflation rates will indicate the constraints upon the European Central Bank (ECB) in their attempt to control the macro-economy through monetary policy. Notably disparate Eurozone national inflation rates would also bring the independence of the ECB into question. ECB independence would be questioned by its monetary policy output and its bias to either sustain the status quo, or, to prioritise inflationary or deflationary pressures. Independence doubts would therefore ensue depending upon whether this prioritisation (intentionally or incidentally) accords to political-economic bargaining power within the Union or not. Therefore, any credible analysis of future interest rate hikes and the revision of QE stimulus must consider idiosyncratic national stances within the aggregated Eurozone figure.



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Mechanisms behind current US Dollar movements

Discussion and Analysis by Charles Porter:


The strength of the Euro against the dollar and the relative weakness of the dollar against other major currencies is primarily explained by adverse dynamics surrounding the US political economy.


Macroeconomic and political uncertainties in the United States (US) is being framed as partially responsible for the progression of the Euro-Dollar exchange rate in favour of the former currency. However, of considerable importance too is the relative strength of the Euro generated by promising macroeconomic performance and the lack of comment on the Euro’s strength by the ECB president, Mario Draghi, upon two opportunities last week.


Currency fluctuations resulting in a weaker US dollar are being blamed on the uncertainty generated by the Trump administration. Specifically, political uncertainty stems from the accentuation of the threat posed by North Korea in addition to uncertainty surrounding the timing of Trump’s promised tax reform and his admonition of disregard for a breach of the debt ceiling. In addition to the political uncertainty that feeding back into currency markets, uncertainty is being fostered by the macroeconomic management of the US central bank, the Federal Reserve.


Macroeconomic uncertainty created by the Federal Reserve is driven by fears of indecision and the uncertainty of future rate-hike timings. Increasing uncertainty around the US political economy is met by a risk-off investor climate. Therefore, as the market moves towards safer assets, of which the US Dollar is a usually quintessential member, the US dollar is being forgone for safer alternatives. The gains that the Euro has and is making against the dollar are arising because the single currency appears relatively more safe than previous evaluations.


On the back of promising data releases over the past weeks and two market-spurring speeches at Jackson Hole and in Lindau by ECB president, Mario Draghi, the Euro appears attractive. Despite the territorial threats unsettling Japan, the Yen has made considerable gains against the dollar this week. Ultimately, therefore, dollar weakness appears to be the driver of major currency fluctuations and exacerbated by the relatively security of other major currencies.


US consumer confidence results, due to be released at 3pm today, will be watched closely given the currency market backdrop. The most recent Eurozone consumer confidence data was strong and US Dollar based exchange rates are likely to be sensitive to the forthcoming data release.


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Part Two: The Week Ahead

Discussion and Analysis by Charles Porter: 

This is an important week across many of the world’s key currencies. With numerous and salient events battling for supremacy and coverage, ultimately, only time will tell what the aggregation of these event holds in store.


Negotiations on the secession of the United Kingdom from the European Union will continue later today. Whilst these negotiations ensue, the European political economy will create a shroud of subtext. Notably, French President Emmanuel Macron will simultaneously be hosting a summit with the German, Italian and Spanish leaders at a European summit.


As if this were not enough to constrain and divert Europe’s attention away from Brexit negotiations, the British prime minister will meet with her Japanese counterpart this week. Prime ministers Theresa May and Shinzo Abe will attempt to foster optimistic evocations of affluent post-Brexit international trade between Japan and the UK.


The formalisation of a post-Brexit free trade deal is thought (although it is contested) to be precluded, and in any case imprudent, under the European treatises. The UK remains bound to these treatises and, specifically, uniquely obliged under the Lisbon Treaty’s Article 50 protocol. However, we look to see if mutual concession making between the UK and Japan may foster optimistic future trading sentiments alongside security and territorial support.


High salience issues are forecast for the agenda at President Macron’s European summit. Therefore, any significant progressions or announcements from the four EU heads of state may either provide a welcome or harmful distraction from Brexit negotiations. A harmful distraction would arise should it diminish public and market perceptions of the sanctity and progression of the UK’s post-Brexit future.


Today’s Brexit negotiations are set to address the concerning future of Northern Ireland. An abundance of admonitions over the strategic deployment of the Northern Irish peace process as a bargaining chip may further constrain these talks. In short, an inability of the Brexit negotiation process to demonstrate a tangible reduction in uncertainty will, ceteris paribus, lead to a further deterioration of the Pound Sterling.


So what could the talks demonstrate in order to strengthen the pound? A meaningful statement or offer on the future right of EU citizens residing in the UK is likely to immediately encourage progress on other grounds. However, the long-run social and procedural implications of this offer are beyond our grounds of speculation and opinion. 


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Currency Fluctuations following Jackson Hole Symposium

Discussion and Analysis by Charles Porter: 


Currency Market Impacts of the first major Jackson Hole symposium event 2017.


The Dollar has seen dramatic intraday devaluation against other major currencies including the Euro and Pound Sterling. Live commentary and reaction was provided on our Twitter Feed whilst Chair of the Federal Reserve Board, Janet Yellen, spoke at the Jackson Hole symposium in Wyoming. Against the Pound, the Dollar fell by a maximum of approximately 0.51% in seven minutes.


Expectations were low for a major revelation coming out of Wyoming from Janet Yellen today. However, markets always listen intently to an occasion where figures of this stature gather because of the concomitant propensity for overhaul. Yellen’s speech, however, fulfilled low expectations. Her speech focussed primarily upon financial regulation and even within this traditionally low-impact, low-volatility, channel, she advocated “modest” action.


Despite some a more ambitious set of expectations hoping to see Yellen addresses the macroeconomy and inflation, there was no mention of monetary policy tightening. As the economy cements its recovery following the credit crisis, each evasion of monetary policy tightening will increase the expectations for an upcoming adjustment of the interest rate. Upon this occasion, we expect immediate market volatility as the market prices in the interest change, uncertainty variation and adjusts to price new risk and anticipated demand.


Graphical illustrations of significant currency changes are presented below this article. For now, markets and our analysts look towards Draghi’s speech later at the symposium. Following his speech earlier this week and the Euro’s subsequent appreciation, it is plausible to see either a reversal of the gains made there or an exaggeration of the Euro’s consistent year to date appreciation. Currency markets will be most interested in whether the European Central Bank President addresses the strength of the Euro and the impending need to end the Eurozone stimulus purchasing programme, quantitative easing. Given the symposium theme, “Fostering the Dynamic Global Economy”, currency stability comments and an indication of stimulus curtailment could well be witnessed.




Above: This graph shows the intraday Euro-US Dollar exchange rate. This rate, equating the two most traded currencies in the world, depicts a maximum change of 0.72% within minutes of Yellen’s speech commencing. The comparable size of the Eurozone and US populations, despite their currencies being used to highly different degrees as a reserve, could entail similar, if not more substantial, movements within the Euro.


Above: This graph depicts the Cable rate, Pounds Sterling-US Dollars. With a magnitude of around 0.5%, the impact that the Jackson Hole speech had upon currency markets is anything by insignificant.


Above: Depicted over the same time period, the graph above shows the Dollar/South African Rand exchange rate. The downward trend this afternoon coincides with Yellen’s speech and represents a sudden devaluation of the Dollar against the Rand.

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Moving Forward: Week’s Review and Outlook Part One

Discussion and Analysis by Charles Porter: 


Part One: The Week in Review


Currency movements this week have been distorted by both opportunistic and defensive speculative reshuffles. Strategic positioning has arisen from the anticipation and sentiment that pivotal currency market actors have adopted preceding this afternoon’s Jackson Hole symposium and impending Brexit negotiation round. Such movements have led to a moderately opaque weekly impression. However, several of this week’s significant events have had discernible and meaningful impacts upon international currency markets.


The Euro gained strength following the ECB president’s speech. This speech strengthened the Euro vis-à-vis the Pound and Dollar due to Draghi’s evasion of the Euro’s sustained year to date revaluation. Similarly, the praise he gave within the academic-style speech to quantitative easing provided a positive environment upon which the Euro rallied. Importantly, this signalled to markets that the Euro would not be forced back down to promote Eurozone exportation.


On the back of such events the Euro would go on to close at the highest level vis-à-vis the pound in almost eight years. Moreover, this appreciation reversed losses against the dollar that the Euro had experienced twenty-four hours earlier. The dollar’s unanticipated appreciation on Tuesday pervaded across international currencies. During this episode, the dollar strengthened by in excess of 0.5% whilst the GBP/EUR rate remained constant. Similarly, losses against the Euro were significant, yet slightly milder, at a little over 0.4%. The dollar’s exchange rate to the Rand also showed considerable volatility with the dollar appreciating considerably.


Sterling’s performance on the back of a revised UK GDP data release was also perceptible. However, in line with expectations, Sterling’s revaluation was small as markets equilibrated to price previous risk out. The Japanese Yen saw insignificant and imperceptible fluctuations following last night’s Consumer Price Index inflation rate publication.


For now, markets look towards the impending Jackson Hole speeches from Janet Yellen and Mario Draghi. Part Two of this article identifies our expectations regarding the Wyoming symposium in addition to the events that we will be looking closely at following the bank holiday.



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Central Banking Part Two: Why Independence?

Discussion and Analysis by Charles Porter: 

How important is Central Bank Independence?


The German model of central banks has triumphed on the European continent, manifested within the European Central Bank, ECB, at least as far as institutional design is concerned. The US Federal Reserve, FED, is slightly less, yet comparably, independent. The Bank of England, BoE, is the least independent. But what does this really mean?


As mentioned within Part One of this analysis, central bank independence can be inversely correlated with accountability. This is a logical relationship because (political) distance is a form of critical insulation. This is clearly a negative attribute to the characteristic of independence which is typically deified.


Despite accountability concerns, independence precludes political involvement in the setting of monetary policy. This means that, for example, preceding a national election, the incumbent party cannot artificially pursue expansionary monetary policy to precipitate economic growth thereby fostering political support. Whilst this may be justified in terms of pure equitability, it is also crucial, according to the ECB, to prevent long-term economic sabotage.


From the perspective of currency markets, it similarly awards confidence in greater exchange rate stability. Interest rates have an immense importance upon the relative valuation of an exchange rate due to the increased/decreased reward for saving or holding the currency that it entails. Therefore, central bank independence leads to confidence that short-term, economically inefficient and volatility inducing manipulations will not occur.


Inter-currency relative central bank independence is similarly important. The ECB is more independent than its US and UK counterparts due to the need to defend itself from idiosyncratic national political monetary-policy demands. Should the ECB architecture not include the necessary safeguards against political dependence, the prioritisation of one country’s monetary policy desires could entail an exceptionally harmful monetary pursuit for another economy. Therefore, to some extent, the outstanding relative independence of the ECB promotes the longevity of the European project: the Eurozone could never survive should the ECB be politically influenceable.


The FED, the US central bank, similarly manages a currency union; the Dollar. So, one might ask why does it not need a comparable independence to the ECB. The complementarity between the architecture of the FED and the superior political and cultural integration within the US is likely to address this question. However, crucially, the FED’s superior independence compared to the Bank of England advances the relationship between monetary unification and central bank independence. Although we have a tendency to forget, the UK is too a monetary union across nations. Harmony is easier to foster as borders become more invisible. Therefore, it may be the case that the complementarity between the architecture of the BoE and the integration of its nations’ citizens facilitates an even lower level of independence.


Tomorrow, we will see the chair of the FED’s Board of Governors, Janet Yellen, and president of the ECB, Mario Draghi, meet together at the Jackson Hole symposium in Wyoming. Our economic analysis will be guided by this understanding of the constraints and responsibilities, determined in part by independence, that the leader of both institutions embodies. An in-depth understanding of the sentiment behind their speeches can subsequently be obtained.



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Central Banking Part One: What independence?

Discussion and Analysis by Charles Porter: 


How independent are Central Banks?


As the chair of the FED’s Board of Governors, Janet Yellen, and president of the ECB, Mario Draghi, meet together at the Jackson Hole symposium tomorrow, it is important to understand the relative roles and stature of each central bank.


The German model of central banks has triumphed on the European continent, at least as far as institutional design is concerned. But how independent are modern day central banks across the globe? The motivation for central bank independence primarily derives from credibility. Central Bank independence, understood as political independence, refers to the inability of political-motivations to manipulate the state of the economy through monetary policy. When it comes to the central bank of a monetary union, the implications, whilst more severe, stem from similar lines.


The European Central Bank, ECB, boasts of its guaranteed institutional, personal, functional, financial and legal independence. Independence is thought to be inversely correlated with accountability (see Part Two). It claims to restore its accountability through a direct link to EU citizens, a common theme throughout the European project, that ultimately only those citizens can be the arbiters of. Since its inception, guided by the 1992 Maastricht treaty, it has followed (and exaggerated) the German model.


This is unsurprising given credible research coming out of the University of Michigan that the construction of the European currency union was dominated by the preferences of the German government. The Bundesbank, although now entwined within the European System of Central Banks, was previously quantified as the world’s most independent central bank. Due to the international, inter-sovereign, composition of the Eurozone, it is unsurprising that political independence is so exaggerated. Independence follows its scope and mandate encompassing only treaty-enshrined price stability.


The Federal Reserve, FED, system operates through a Board of Governors. Targeting three macroeconomic goals, the FED’s independence is diluted. By convention and numerous quantification techniques, the FED’s independence remains strong. However, its independence remains inferior to that of the ECB. As will become clearer within the second part of this article, the FED manages to remain more accountable than the ECB through its relative political dependence. This represents a challenging trade-off.


The Bank of England’s, BoE, independence was developed in 1997 under the chancellorship of Gordon Brown. The substance of its new independence was freeing the Bank to set its own interest rates in order to target a politically-set long-term inflation rate. Monetary instruments are revised under a Policy Committee which meets eight times each year. A mandate for macroeconomic management outside of the price level again questions the independence of the BoE. Prior, to 1997, its independence was far inferior to the US Federal Reserve Bank and the BoE’s current independence threshold.


Listed above in order of independence, the ECB, FED and BoE, are all highly independent in comparison with less developed world economies. However, the considerable disparity within the independence of the central banks of three major (reserve) currencies lead to an important question: how important is Central Bank Independence?


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Forthcoming UK GDP Growth Revision

Discussion and Analysis by Charles Porter: 


Sterling Rates Calm as Markets await Bigger News.


The Office of National Statistics is scheduled to release a revision of quarter two economic growth this morning. Economic growth figures can be calculated from the release of seasonally adjusted Gross Domestic Product data measured in chain linked volumes. The inter-quarter differential for 2017 currently stands at £1415m. Inter-quarter percentage economic growth on the back of this change stands minutely above 0.3%.


Sterling currency markets are unlikely to be affected by today’s revision because the dominant market expectation sees no change to this figure. In the event of an unanticipated upward (or downward) revaluation to GDP growth, the propensity for sterling to receive a boost (or slump) could either mediate (or exacerbate) yesterday’s dramatic losses vis-à-vis the Euro.


For now, markets look more intently towards the Jackson Hole symposium at the U.S Federal Reserve. Mario Draghi, president of the European Central Bank, will speak at the event tomorrow. Draghi’s speech yesterday contributed to a bullish Euro by praising, and not undermining, the Quantitative Easing purchasing program. However, with the ‘just below 2%’ inflation target threatening to stray away, markets watch whether Draghi will acknowledge or, better, detail the need to remove this stimulus.


Speaking at this event too will be Janet Yellen, the Federal Reserve chair. Wyoming’s high-powered event will therefore attract media and investor attention whilst the German election draws closer. Therefore, with considerable news events approaching, bigger currency market fluctuations are credible in the near future.