UK – from maverick deserter to early-mover with clear purpose
Brexit no longer appears to be a maverick move by a recalcitrant deserter, but an early move in a global trend towards nationalist anti-establishment politics that many countries, especially in Europe, must face. UK PM May is a strong and capable leader and her speech on Tuesday set out clear objectives and a sense of purpose that setup the UK well for negotiations with the EU. While she offers partnership and support for the EU, she has prioritized seeking stronger trade and economic relationships with the rest of the world. In many respects, her position might be regarded as enviable by several countries inside the EU struggling with the restraints of membership. So far the UK economy has far exceeded expectations of economic catastrophe. In fact, it continues to show solid economic performance, and inflation above expected, both generating upside risk for UK rates and the GBP exchange rate.
The USD continues to fall more than we expected this year, despite virtually every economic policy proposed by Trump being dollar positive (including corporate tax cuts, tougher trade deals and immigration controls, border taxes, tax incentives to repatriate profits, and infrastructure spending). However, Trump’s transition has prioritized less growth-supportive policies (repeal and replace Obamacare), highlighted divisions with Republicans in Congress over Russia, China, and tax policies, been distracted by a range of side issues, and has failed to generate more widespread public support. Trump called the USD too strong, but, perhaps more concerning, he made confusing comments that display a lack of appreciation for the detail in his policy ideas. Uncertainty over the Trump presidency remains high, tending to undermine confidence in the USD.
Brexit hope may soon overcome fear
The risk related to Brexit remains high, but it has not got any worse over recent months. Britain under PM May has been talking in terms of a hard Brexit for months, so it is difficult to understand why the market turned more bearish ahead of the speech by May on Tuesday. The snap-back since her speech suggests that a lot of the downside risk associated with Brexit is in the price.
We see scope for sentiment towards the UK, in an albeit uncertain future, to improve from current levels. Part of the reason is that Brexit is the manifestation of the anti-establishment nationalist sentiment that has become apparent in most developed economies and, to some extent, the UK may be viewed as an early-mover rather than a maverick.
PM May has the cache to make it work
An important factor in support of the UK Brexit outcome is that UK PM May appears to be very sensible, credible and has the respect and support of her party and the public. She is likely to command respect in negotiations with the EU. The same cannot be said for many other leaders of countries that have experienced or are in the process of experiencing a rise in nationalist public sentiment.
Outside partner or Recalcitrant deserter
A point of concern for the UK has been that EU leaders have often said that the UK cannot have its cake (control over immigration) and eat it to (access to the single market). And that the EU needs to punish the UK for leaving the EU so as to discourage other possible leavers.
It remains true that the UK will not eat the same cake as before and many EU leaders will start from a tough negotiation position. However, as time passes, the need to punish the UK will be less obvious, and sympathies for the UK position will increase. The EU will begin to become more introspective and focus on why Britain voted to leave and attempt to address internal concerns rather than focus on punishing Britain.
The EU is facing its own existential threats and it may prefer to seek more support from Britain as an outside partner rather than as recalcitrant deserter. PM May offered this olive branch to Europe. She said, “It remains overwhelmingly and compellingly in Britain’s national interest that the EU should succeed. And that is why I hope in the months and years ahead we will all reflect on the lessons of Britain’s decision to leave.”
UK seeks greater global trade
The market is well aware of what Britain stands to lose as it leaves the EU single market, but it has focused less on what the UK stands to gain as it seeks trade and economic relationships outside of Europe. This is a point that PM May attempted to drive home in her speech on Tuesday.
She said, “Important though our trade with the EU is and will remain, it is clear that the UK needs to increase significantly its trade with the fastest growing export markets in the world.
Since joining the EU, trade as a percentage of GDP has broadly stagnated in the UK. That is why it is time for Britain to get out into the world and rediscover its role as a great, global, trading nation.
This is such a priority for me that when I became Prime Minister I established, for the first time, a Department for International Trade, led by Liam Fox.
We want to get out into the wider world, to trade and do business all around the globe. Countries including China, Brazil, and the Gulf States have already expressed their interest in striking trade deals with us. We have started discussions on future trade ties with countries like Australia, New Zealand and India. And President Elect Trump has said Britain is not “at the back of the queue” for a trade deal with the United States, the world’s biggest economy, but front of the line”
Prioritizing new global trade deals
A significant area of concern in the market is whether the UK can begin and finalize trade agreements outside of the EU before it has completed Brexit. At issue is whether the UK can continue to enjoy tariff-free trade with the EU remaining inside the EU Customs Union.
PM May could not provide clarity on this issue, but she sees a way for the UK to push on with trade deals outside the EU while seeking on-going benefits of the Customs Union. One might conclude from the overall tone of her speech that seeking new trade deals outside of the EU is a priority, but she will work hard to maintain as much free trade with the EU as she can.
She said, “I want Britain to be able to negotiate its own trade agreements. But I also want tariff-free trade with Europe and cross-border trade there to be as frictionless as possible.
That means I do not want Britain to be part of the Common Commercial Policy and I do not want us to be bound by the Common External Tariff. These are the elements of the Customs Union that prevent us from striking our own comprehensive trade agreements with other countries. But I do want us to have a customs agreement with the EU.
Whether that means we must reach a completely new customs agreement, become an associate member of the Customs Union in some way, or remain a signatory to some elements of it, I hold no preconceived position. I have an open mind on how we do it. It is not the means that matter, but the ends.
And those ends are clear: I want to remove as many barriers to trade as possible. And I want Britain to be free to establish our own tariff schedules at the World Trade Organisation, meaning we can reach new trade agreements not just with the European Union but with old friends and new allies from outside Europe too.”
Seeking Maximum Certainty
PM May said that, “as we repeal the European Communities Act, we will convert the “acquis” – the body of existing EU law – into British law.
This will give the country maximum certainty as we leave the EU. The same rules and laws will apply on the day after Brexit as they did before. And it will be for the British Parliament to decide on any changes to that law after full scrutiny and proper Parliamentary debate.”
“Maximum certainty” in an inherently uncertain process should help alleviate some risks for the UK economy.
She also said, “I can confirm today that the Government will put the final deal that is agreed between the UK and the EU to a vote in both Houses of Parliament, before it comes into force.” This might be regarded as created some uncertainty in the sense that an agreement will need to draw support from parliament. But on the other hand, she would face criticism for not seeking broader ratification, and debate would ensue over the right of parliament to have a final vote. In this sense, this decision helps guide the process and provides more clarity.
A reasonable position on immigration
Immigration is a hot-button topic in many countries, particularly in Europe. May’s position leaves no suggestion that this is about xenophobia, and it will sound entirely reasonable to many countries and serve Britain well in negotiations with the EU.
May sought to make it clear that immigration is still wanted, but the desire is to control the numbers. She said, “Filling skills shortages, delivering public services, making British businesses the world-beaters they often are – when the numbers get too high, public support for the system falters.”
She said, “Britain is an open and tolerant country. We will always want immigration, especially high-skilled immigration, we will always want immigration from Europe, and we will always welcome individual migrants as friends. But the message from the public before and during the referendum campaign was clear: Brexit must mean control of the number of people who come to Britain from Europe. And that is what we will deliver.”
She made a priority seeking certainty for the rights of EU citizens living in the UK and British citizens living in the EU. Apparently, she is not looking to deport EU citizens and supports ensuring the rights of workers as quickly as possible. This should go a long way to appeasing the concerns in newer Eastern members of the EU, some of the most strident critics of the UK since the Brexit vote.
Leaving the Single Market
May made it clear, the UK understood it was leaving the EU Single Market. As such, it places in jeopardy freedoms of trade that support the UK economy. But of course, this should be no surprise to anyone. The uncertainty this creates is not new. But May is seeking as much freedom as she can on trade with Europe. Uncertainty prevails, but May is making all the right noises as a reasonable and supportive partner for Europe, providing the opportunity for a future trade deal to not be punitive.
She said, “We do not seek membership of the Single Market. Instead we seek the greatest possible access to it through a new, comprehensive, bold and ambitious Free Trade Agreement.
That Agreement may take in elements of current Single Market arrangements in certain areas – on the export of cars and lorries for example, or the freedom to provide financial services across national borders – as it makes no sense to start again from scratch when Britain and the remaining Member States have adhered to the same rules for so many years.”
Red lines and veiled warning
May argued firmly that punitive actions by Europe would be in neither the EU’s or the UK’s interest, and said, “Britain would not – indeed we could not – accept such an approach. And while I am confident that this scenario need never arise – while I am sure a positive agreement can be reached – I am equally clear that no deal for Britain is better than a bad deal for Britain.
Because we would still be able to trade with Europe. We would be free to strike trade deals across the world. And we would have the freedom to set the competitive tax rates and embrace the policies that would attract the world’s best companies and biggest investors to Britain. And – if we were excluded from accessing the Single Market – we would be free to change the basis of Britain’s economic model.”
May mentioned all the benefits the UK provides to Europe, including the export and investment revenue European companies gain from the UK. But perhaps, more importantly, she outlined the support the UK military and intelligence services provides to the EU. The purpose was, of course, to illustrate that the UK is not without negotiating power in the coming Brexit discussions.
Theresa May’s Brexit speech in full – Telegraph.co.uk
Trump distractions
The USD has continued to retreat faster than we had expected this year. It has more than reversed it gains against most countries since the more hawkish than expected FOMC meeting on 14 December.
It is evident that some of the euphoria for US economic growth that followed the election of Trump on 8 November has dissipated. This may reflect shifting perceptions on the priorities of Trump and the ongoing combative style his presidency promises. Media coverage of Trump in the USA has focused more on his Twitter responses to various distractions unrelated to economic policy. Corporate tax reform and infrastructure spending appear to have taken a back seat to repealing and replacing Obamacare, micro-commentary on specific companies, border tax, and building a wall on the Mexican border.
It is beginning to look like the Trump agenda will be bogged down in issues that do little to support growth and economic confidence. This may be dampening the US stock market performance, weighing on yields and the USD.
Trump views on the dollar lack credibility
The interview Trump gave to the WSJ on Wednesday has contributed to a further decline in the USD. The WSJ reported that Trump said: the U.S. dollar was already “too strong” in part because China holds down its currency, the yuan. “Our companies can’t compete with them now because our currency is too strong. And it’s killing us.”
The yuan is “dropping like a rock,” Mr. Trump said, dismissing recent Chinese actions to support it as done simply “because they don’t want us to get angry.”
These comments lack consistency and fail to inspire confidence that Trump understands what is driving the USD or the Chinese yuan.
The idea that Trump thinks the USD is “too strong” appears to have undermined the currency. However, Trump has no apparent way to control the currency. Most of his policies, (including a border tax, pursuing tougher trade agreements, tax cuts, and potential tax breaks for repatriating profits, infrastructure spending and tougher immigration enforcement), are directly and indirectly inflationary and may induce higher US interest rates and a stronger USD in the short to medium term.
The disagreement Trump expressed on the border tax proposed by his Republican colleagues in Congress may also have weakened the USD.
On the one hand it points to an inconsistency in Trump’s thinking on a border tax, highlighting the difficulties that arise when trying to implement an idea that sounds simple in sound bites, but comes with negative consequences that cannot be uncoupled from the desired effects. Naturally, the idea of a border tax is meeting resistance from US industry.
Donald Trump Warns on House Republican Tax Plan – WSJ.com
GOP Proposal to Change Tax Treatment of Imports and Exports Raises Questions – WSJ.com
Trump is reported in the WSJ to have said the Republican border tax is “too complicated”. The WSJ reported: “Anytime I hear border adjustment, I don’t love it,” Mr. Trump said in an interview with The Wall Street Journal on Friday. “Because usually it means we’re going to get adjusted into a bad deal. That’s what happens.”
Trump has made a number of warnings to companies in recent weeks that they will be hit by additional taxes if they move production to Mexico and try to export goods to the USA. This included even German car manufacturer BMW. This sounded like he was a big supporter of a border tax, or something very similar to it. And yet he is reported in the WSJ making glib comments about being adjusted into bad deals, vaguely criticizing the idea.
A border tax or other ways to discourage imports should place upward pressure on the USD, exactly a reason why some commentators are critical of the policy; noting that a rise in the exchange rate may negate the benefits of such a policy, but leave in place other distortions that tend to undermine economic growth.
If Trump is not sure about the policy, then it may be a reason to think it may not happen or be bogged down for some time, relieving some immediate reason for a stronger USD. But perhaps more broadly it points to a delayed and uncertain pathway for meaningful policy implementation and less reason to see Trump as a catalyst for change.
Trump has picked some well-respected individuals to his cabinet. But they have made a number of comments during confirmation hearings that appear to contradict several policy ideas floated by Trump. This may also be generating an appearance of a lack of direction and purpose. There remains a great deal of uncertainty over the type of leader Trump will be, and creeping uncertainty that his capacity to do deals will not live up to initial lofty expectations.