The Blog

Stars Align for Osborne and Carney as the UK Stands Out

If last week's markets were quiet and range-bound due to Thanksgiving celebrations and a paucity of frontline data, this week could hardly present a more different proposition.

If last week's markets were quiet and range-bound due to Thanksgiving celebrations and a paucity of frontline data, this week could hardly present a more different proposition. Yesterday saw a strong US Manufacturing ISM survey, and today the RBA decided to sit on its hands, but the committee was once again at pains to point out that they view the AUD's strength as "uncomfortably high", with a "lower level of exchange rate likely to be needed to achieve balanced growth in the economy". They also highlighted that "public demand is forecast to be quite weak" and "considerable uncertainty surrounds this outlook", (for a pick-up in activity). More rate cuts are coming in Australia as Asia slows. The RBA are very perceptive-they realise that the Chinese 3rd plenum, although very constructive in the medium-term, (10-20 years in Chinese terms!), implies slower growth in the short-term, as the economy re-balances away from export-fest to the kind of consumer-lead growth that is all too familiar to us in the UK.

Australia will be massively effected by the Asian slowdown and recent words from Unilever Chief Executive Officer Paul Polman, (Dec. 2-Bloomberg), are immensely significant, given Unilever's position as a bell-weather producer of consumer goods across emerging markets; "They are still relatively stronger economies but still fragile," plus, "And you see that growth coming off now a little bit, obviously not being helped either by lower demand coming from Europe and the U.S. This will last a few years. And it will only be corrected if some of the reforms have been made in these places."

We are entering a dangerous era of change for global growth, with the onus being passed to developed markets to take over as locomotives. Really?! With an economic block the size of the Eurozone destined to flatline for years to come, or implode, and a US economy that will struggle to reach escape velocity as the Fed removes the punch bowl, this looks like a vain hope. Just look at the effect on the US housing market of even the suggestion of tapering and a 100 bp rise in mortgage rates this summer-and the housing recovery has played a very significant part in what meagre growth we have seen thus far.

The Fed seems set on a path to QE tapering, (March is my central scenario), accompanied by strengthening of forward guidance to try and persuade the market that tapering doesn't mean more imminent tightening. I think they'll struggle to achieve this and to give themselves a better chance of success they should announce a reduction in the employment rate threshold for Fed Funds rises at a meeting occurring before that at which they announce tapering, and the new threshold needs to be 5.5%, not just 6.0%.

Against this backdrop, Messrs. Osborne and Carney are beginning to look pretty lucky, (and smart actually), with the UK fast becoming the stand-out developed economy performer. Growth is heading into 2014 at a healthy 3 to 4% annualized clip, even in the face of Osborne's austerity, which is another good story-in his December 5th Autumn Statement, I expect Chancellor Osborne to be able to announce that the OBR has made a £13bn reduction in its official forecast for the 2013/2014 government deficit, compared to its March forecast, i.e. 5.8% of GDP, rather than 6.9%, and also to make reductions in deficit forecasts for the future. I would also expect upward revisions to growth prognoses.

Governor Carney seems to be fully on-board in helping out the Chancellor, with repeated promises that rates will stay lower for longer than recent positive data surprises would otherwise suggest. Last week's decision by the Bank of England to restrict its Funding for Lending Scheme to the provision of cheap liquidity to banks for business lending, rather than also for household mortgages, also implies a concrete, and rather subtle, message that the Bank will use macro-prudential tools to cool parts of the economy if it deems this necessary and NOT conventional monetary tightening. This having been said, I'd say this change in policy will have negligible effect on the UK housing market, as cheap liquidity is currently plentiful anyway, and the government's two Help to Buy schemes will be the real policy drivers of the housing market-eventually achieving the Nirvana of increased home building, as well as the feel-good factor from higher prices that British homeowners crave like the next heroin high. I would be extremely surprised if Help to Buy was altered at all before the next election in May 2015.

The real question is whether the UK can continue to thrive in the face of headwinds from Europe, Asia and even possibly the US.

The week will conclude with a bang as we digest November's US employment report-hopefully no longer distorted by the shutdown, but I'd expect not strong enough to propel the Fed into a December meeting tapering, especially when one takes into account the trouble they would have discerning employment trends, given the questionable veracity of recent reports, due to the shutdown.