Daily Brief – Battle of the banks

Battle of the banks

Market volatility continues amidst unclear messaging from both sides of the conflict in Iran. The President’s position has continued to flit between seemingly concrete positions of absolutely tangible progress and bombing the nation back ‘to the Stone Ages’. Since the start of the war, smarter money has acknowledged that predicting the path and even end of this war is improbable if not impossible. However, the war is still tradable, we suspect, just not if you’re trading the obvious aspects of when and with what degree of order the regional conflict will conclude.

The strongest ‘known known’ is that the war has created volatility and a risk to inflation. Regardless of how long the war will go on for, this fact will remain true. The degree of magnitude of the inflationary threat will change depending upon how well and how soon the war is resolved. However, at this stage it is impossible for that damage to be entirely unwound. This inflationary spike, even as far it has been transmitted already through primarily commodity prices but also via inflation expectations and broader price levels, will create different winners and losers.

The key to this is that the inflationary impact won’t affect all nations equally. Take the Eurozone versus the UK for example, a dependency within the former upon LNG versus oil in the UK means inflation won’t be imported in the same way. In the USA, the story is different yet again – at the national level, as a net exporter of oil, rising prices are positive for output and net exports but at the consumer level they threaten consumption immensely. A step yet further comes when we look at the approach of respective central banks and herein lies the key. The mandate of the ECB, for example, considers only inflation. Whereas the Fed and BoE, to some extent, have a concern for the wider economy including elements such as growth and employment. A pure focus on inflation could leave ECB pricing stickier at the front end than the BoE or Fed. This explains what we have seen yesterday with GBPEUR falling circa 1 cent. Of course, yesterday’s move was reinforced specifically by Governor Bailey’s comments but underlying this is the ability for the market to react faster to BoE comments versus an increasingly more hawkish ECB.

Discussion and Analysis by Charles Porter

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