BREXIT – 1 YEAR ON
It seems not so long ago since UK citizens voted to leave the European Union following the widely unexpected result which was revealed on the 23rd of June last year, economists, politicians and investors have been speculating on what lies ahead for the UK. The largely pessimistic views from the ‘Remain’ campaigners have been muted in the wake of positive results in the UK stock market and the resilience of the economy.
What happened over the year?
The pound’s one day drop of 8% after the referendum result was announced heralded a fall in the value of sterling down to $1.2047, its lowest level in 32 years. Since then it has recovered slightly to $1.30. Weaker sterling affected UK residents in two ways; first, travelling became more expensive so expenditure abroad dropped 2.4% over the year to the end of April, and second, the weaker pound has put pressure on import costs pushing up the overall costs of goods and services – inflation.
One advantage of having a currency which has depreciated significantly is that it makes goods and services from the UK more attractive to international buyers, with exports increasing 11.4%. Expenditure from overseas visitors to the UK has grown 18% over the year (since April 2016), as tourist arrivals increased almost 22% according to the Office for National Statistics. The increase in exports reduced the trade deficit by 7.2% and meant the UK received more orders from abroad which in turn has led to higher levels of production and falling unemployment.
The longer term impact of the UK leaving the EU is not known. UK Brexit Secretary David Davis started the negotiation process with his European counterpart Michel Barnier last week agreeing that 3 million EU citizens living in the UK will be granted a “settled status”. However, no further agreements on immigration or trade have been made yet. With Article 50 now triggered, the UK must negotiate terms and officially leave the EU no later than April 2019. While the media has made much of the dangers of leaving the Union, it will be up to Davis and his negotiating team to secure a platform on which the UK can build to take advantage of the significant opportunities independence can bring.
The three day central bank forum hosted by European Central Bank (ECB) President Mario Draghi, and attended by Bank of England (BoE) Governor Mark Carney, Bank of Japan (BoJ) Governor Haruhiko Kuroda and Bank of Canada (BoC) Governor Stephen Poloz shed some light on the current outlook of central banks.
The general tone was that monetary stimulus programmes were likely to see some tightening. In contrast to recent comments suggesting UK rates were likely to stay on hold until 2019, Mark Carney (BoE) indicated that the time to increase rates may be approaching. This pushed sterling to $1.30, its highest point since the Brexit vote last June. Mario Draghi (ECB) also made comments arguing that the European economy was improving and that there was room to adjust the current stimulus programme. Even though the ECB kept interest rates at zero, the risk outlook has been upgraded to “broadly balanced” indicating that a curtailing of the Asset Purchasing Programme (Quantitative Easing) may lie ahead. Investors perceived this message as ‘very’ hawkish, prompting a jump of 2% in the euro this week to a new 1-year high of 1.1412 against the dollar.
Despite the generally hawkish views from the ECB forum and US Federal Reserve Chair Janet Yellen, economic fundamentals have to be strong for central banks to implement tightening measures. As any adjustments in the short-term are unlikely and central banks remain cautious, we are likely to enter a period of ‘wait and see’ which could be positive for both European sovereigns and US Treasury holders as they should continue to hold their value.
US CONSUMER SENTIMENT
The University of Michigan Consumer Sentiment Index (UMCSI) is a survey of 500 households across the United States. The households are surveyed on current and future expectations of variables such as consumption, financial wealth, business conditions, employment and income. The current and future expectations figures are put together to calculate the headline figure.
To understand the meaning of the number posted we must take a historical perspective. Historically, the UMCSI figure has averaged 86.1. The current UMCSI figure sits at 95.1. This indicates that US consumers are currently more confident than in the past. The graph below illustrates the strong correlation between the UMCSI and S&P 500 Index since 2008.
The UMCSI vs. S&P 500
Source: University of Michigan & Bloomberg, 2017
More recently, we saw a 2-year low in the UMCSI surrounding the US election, with a September low of 87.2, the lowest since September 2014. However, following the election result and the subsequent ‘Trump rally’ in markets, the UMCSI rose substantially to a high in January of 98.5. Thereafter, the index cooled off and has remained around 96.
This is representative of the US economy with conditions beginning to calm as Trump finds that promises that were easy to make on the campaign trail are harder to implement once in office. Nevertheless, consumers still appear more confident of the US economy then they have been historically. With policy makers increasingly looking at levels of personal borrowing, the UMCSI will provide a valuable insight into US consumer confidence as monetary tightening begins to take effect.