Not for the first time, and certainly not for the last time, the words “Brexit” and “Trump” have dominated financial media headlines.
After months of prevarication and procrastination, UK PM May finally laid out her government’s plans as to what form of Brexit they are seeking. The commitment to leave the single market (and, de facto, the EU customs union) means that it will be of the “harder” variety. But the stated intention to deliver a “smooth and orderly” exit, ie. no cliff, combined with the largely pro-EU British parliament getting a vote on the final deal certainly helped soften the edges.
The Trump Effect
Meanwhile, President Trump – as one can now call him – continued to muddy the international waters by threatening German carmakers that he would seek to impose a 35% tariff on imports to the US made by their Mexican subsidiaries; a statement that earned a pithy reply from the German Vice Chancellor, namely that if Trump wished to see more American cars on 5th Avenue they should “make better cars”.
These latest developments are an important and timely reminder that even though investors have had several weeks/months to digest what were for many the two big political upsets of 2016, dividing the medium-term macroeconomic and financial market implications, both domestically and internationally, remains extremely challenging given the ongoing and considerable uncertainties.
Despite all of his talk – not to mention numerous tweets – Trump is still very much an unknown quantity given his lack of experience in political office. Similarly, PM May has laid out her stall as to what she is seeking in the Brexit negotiations (her speech contained 12 key guiding principles) but the eventual form of Brexit is not set unilaterally. It is a negotiated outcome, hence the end result is still unclear.
As can be seen in the chart below, the deep pessimism towards UK economic growth observed immediately following the June 23rd referendum vote has now abated, albeit at a more measured pace than was witnessed in late summer. Similarly, and very much in mirror image, economic uncertainty has also declined, indicating that the prevailing view of the crowd is that the “hit” to the UK economy from Brexit will be not terribly significant.
This relatively benign assessment may, in the end, prove to be overly optimistic. Nevertheless, it is important to recognise the current neutrality of the crowd when it comes to thinking about the near-term trajectory for the UK economy and the pound because although the eventual destination may still be opaque, the journey – any journey – is just as much determined by the starting point as the end point.
Specifically on the currency, the recent four-big figure rally in pound/dollar after the retest of last October’s “flash crash” lows has got some investors pondering whether the depreciating trend still has legs.
If, as was the situation back in late July / early August, sentiment towards the UK currency was extremely negative one would have more sympathy with this view. But, as just shown, this is patently not the case at present. Hence, one remains bearish on the medium-term outlook for the pound and view any near-term rebound as simply an opportunity to get better entry levels.
Certainly, the macroeconomic rationale for the pound to continue to weaken remains sound. A currency’s trajectory is not simply a barometer of an economy’s health as some commentators would have us believe. Rather it should be more correctly viewed as an important additional, externally-focused, release valve.
For an economy as externally unbalanced as the UK – the current account exceeded more than 5% of nominal GDP in 2015 (a post-war wide) – currency depreciation is a growth-supportive imperative because it reduces the onus on domestic demand contraction to drive the rebalancing process.
The BoE Reacting
That is, of course, as long currency weakness does not lead to a sustained rise in inflation, something that would, by jeopardising BoE compliance with their policy mandate (a crucial consideration for a central bank that values its operational independence) likely prompt a monetary tightening from the occupants of Threadneedle Street.
So far, the BoE has been rather relaxed about an inflation overshoot as evidenced by the fact that the UK monetary policy stance has been unalterably accommodative despite the BoE’s last Inflation Report (November 2016) showing inflation forecasts consistently exceeding the 2% goal over the two-year-ahead projection horizon.
This should not, though, be viewed as complacency on their part. Indeed, in his latest speech, BoE Governor Carney presented a thorough examination of a central bank’s loss function, explicitly considering the trade-off between compliance with the target and likely negative impact upon the economy; clear evidence they are well aware of such perceptions.
That said, with the December inflation numbers coming in above expectations (the y/y rate rose to 1.6%, a two-year high), market chatter that the BoE could be forced into reconsidering its accommodative policy stance could strengthen, providing a temporary fillip for the currency.
The good news for the BoE, the UK economy, but not the currency, is that crowd-sourced UK inflation sentiment, which surged after the Brexit result, has fallen back markedly over recent weeks. This strongly suggests that even if near-term UK inflation outturns are stronger than anticipated, it is still largely a transitory shock (see chart below); one that should not warrant a response from the BoE.
Referring back to May’s Brexit speech, one of the more interesting aspects was her attempt to pivot the post-Brexit narrative away from one of international disengagement to one of profound internationalism.
“June the 23rd was not the moment Britain chose to step back from the world. It was the moment we chose to build a truly Global Britain.”
We cannot be the only ones who saw the uncomfortable juxtaposition between May’s “unleashed from the legislative bonds of EU bureaucracy we can embrace new overseas markets” viewpoint and the escalating protectionist rhetoric from President Trump mentioned at the outset. Sure, Trump has said that he wants a fair and swift trade deal with the UK – a marked changed of tone from his predecessor – but if trade tensions are escalating globally it is difficult to see how Britain will achieve such lofty internationalist ambitions.
Trump’s rhetoric is largely just that, rhetoric; part of his famed hard-ball negotiating tactics. However, even if this interpretation is correct, and his statements are political posturing, one cannot help but have misgivings.
The Davos speech by Chinese President Xi – the first time a Chinese official of such seniority has attended the WEF – not only allowed the Chinese to position themselves on the moral (economic) high ground by extolling the merits of globalisation but also implicitly highlighted their profound sensitivity to this subject. In such situations, misinterpretations can very easily lead to unintended but nevertheless unfortunate outcomes.
The US Market Outlook
As noted in previous Market Insights (and tweets) in the weeks following Trump’s unexpected victory the crowd displayed some very definite views as to how the US economic outlook would evolve: in a word “reflation”. Buoyed by anticipated fiscal stimulus of the most multiplier friendly kind (ie. infrastructure), previous negativity towards US economic growth evaporated and inflation sentiment took off.
However, just as in the UK, the reflation balloon has developed an increasingly audible hiss of escaping air. Such a reversal in the US inflation outlook sentiment indicator (see chart below) is consistent with the crowd beginning to shift their focus away from Trump’s reflationary domestic economic agenda to the potentially less positive international ramifications of his policies.
Furthermore, this is not the only marker in the crowd-sourced sentiment data that could be signalling more cautious crowd attitudes towards a Trump presidency. One obvious corporate casualty from any significant US-China trade spat would be Apple, a company deeply reliant on a fully functioning global supply chain, given the bulk of its production, especially the iconic iPhone (a key revenue source), comes from China.
As shown in the final chart, while it may not be readily apparent from market prices – a rising tide floats all boats – one notable corporate absentee from improved crowd sentiment following Trump’s victory is the US tech giant. In early November, crowd-sourced sentiment and optimism towards Apple peaked and has been falling ever since, indicative of increasing pessimism.
Maybe this reversal in sentiment towards Apple is due to idiosyncratic corporate factors, but then again, maybe it isn’t!
Financing for Green Sustainable Development
Green sustainable development has been on multiple discussions channels. Talks, seminars, workshops, you name it. However, financing it has not been thoroughly discussed. How do we finance sustainable green development? Is it profitable for companies who do so? Is the rate of return high enough to cover the cost of investing in green technologies?
No doubt, green sustainable technology is an expensive technology with no clear ROI. Venturing into green technologies may be a blind-man guided only by a voice in his head. Yes, green sustainable technology yields a significant Marginal Social Benefit (MSB). But often, MSB is non-quantifiable.
Leading this social-technology movement, Jeffrey Sachs, with the support of foundations such as the Jeffrey Cheah Institute, established the Sustainable Development Goals (SDG) centre in the backdrop of academics – Sunway University.
The aim is to directly address the issues for SDGs and to ensure the goal set in the Paris Climate Agreement is able to be achieved successfully.
Now, as mentioned, private firms are both afraid and pessimistic about green sustainable development. Many do not see the outcome of this initiative and are not concerned about the environment. The technology is costly, and some firms are even struggling to break-even at their current costs. Lack of momentum from firms involved in similar industries and lack of financial support has made venturing into green technology unattractive.
On 14th of January 2018, pioneers and advocates from across the globe were invited to join a workshop at Sunway University. The idea was to bring together a group of academics, from the Asian Development Bank Institute to representatives from New Zealand and Austria, to discuss how to finance green sustainable developments. It attracted a number of firms involved or who wanted to be involved in this movement.
Financing models such as the SIB model and the Yozma model were introduced by Dr Hee Jin Noh. Papers on the theoretical relationships between a firm, a bank, and households were presented by Dr Maria Teresa Punzi. And the outcome of these series of workshops will be a book, which aims to provide a better insight and guideline for green financing, written by Dr Hee.
Also presented was a case study, comparing different countries. Associate Professor Ivan Diaz-Rainey had made comparisons on some successful countries, looking at European countries versus New Zealand and Australia. In the case study, countries were compared, and recommendations were made on how to make green financing successful. Though the definition and KPIs of a successful green development country are still vague, countries from Europe are exemplary on the ‘theory to practice’ phase.
While there is a significant increase in awareness and wanting to be involved by private firms, it needs to be supported by the government more. Regulators need to provide sufficient information to assist private firms venturing into green technology or green development. A healthy government support will increase the chance of a firm venturing into green development being successful. And these are the baby steps needed in order for transformation at city-scale or nationwide-scale.
Smart Cities Take Off
Big tech deals took off in 2017 as big tech firms strived to make smart cities a reality.
Editor’s Remarks: In 2017, 35 agreements were reached between various cities around the world and big tech companies – a huge increase from the eight that were agreed in 2016. Alphabet has launched a project to develop a miniature smart city in 12 acres of land it purchased in Toronto. Meanwhile, Alibaba is leveraging digital infrastructure in Macau, where its smart transport systems will hopefully improve efficiency for the municipal government. Saudi Arabia has also announced a plan to build a new city, to be named NEOM, which will rely fully on renewable energy as well as self-driving vehicles and drones.
Read more on Big Tech:
Bayeux Tapestry on Loan
Emmanuel Macron has offered to loan the famous tapestry to the UK in an effort to improve relations.
Editor’s Remarks: The offer is expected to be announced this Thursday, when Macron will meet UK officials at the Anglo-French summit at Sandhurst. The Bayeux Tapestry was commission by William the Conquerer’s brother to celebrate his 1066 conquest of England and depicts the Norman king defeating the Anglo-Saxon ruler King Harold. Although it was made in England, the piece – which measures about 35 square metres – has remained in France for the past 940 years. At the upcoming summit, Macron is also expected to petition the UK to join his combined European military initiative – a move many expect Britain’s new defence secretary Gavin Williamson to push back on.
Read more on Europe:
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