This might very well go down as a historic week. 2 deals of potentially game changing significance appear to have been favourably concluded, but in each case observers are as concerned about their imperfections and sustainability as they are excited about the successful outcomes themselves. On the one hand we have the Greek bailout, and on the other we have the Iranian nuclear deal. We might look back in a decade and say, “that was the week”, for good or ill. We cannot know this yet, we are swept helplessly onwards in the relentless currents of uni-directional time.
As always with markets, the anticipation has elicited more reaction than the event itself, so the 15% fall in oil price over the last month or so has been followed by a corrective bounce when it became clear that a deal with the Iranians was imminent. Iran should be quickly able to add supply to the market, and over time will be able to invest to expand capacity. I can think of a lot of competitors who will not see this as anything but bad news, but it is what it is. Experts are rushing to downgrade their oil price forecasts for the periods ahead. Bad for producers, but great news for central banks everywhere I would imagine. This of course is as long as the Iranians comply with terms of the deal, it is by no means certain that they will, but economic self-interest will be an encouraging factor.
In Greece, Prime Minister Tsipras has already admitted that he doesn’t believe in the bailout deal, but he had no choice but to sign. I’m not sure this is going to inspire the legislature to enact the requirements, but I’m ready to plead complete ignorance where Greek politics is concerned. The bottom line is that in both situations there is a great deal of uncertainty surrounding the willingness of one side of the negotiation table to comply with the agreements. This will keep volatility a bit higher at least in the short term.
Yesterday, Governor Carney of the Bank of England put interest rate hikes firmly back on the agenda and the pound ripped higher. Even though he was clear that rises will be gradual and limited GBP/USD moved impressively from the 1.54s to the 1.56s in fairly short order. Bear in mind these comments were after slightly softer than expected inflation numbers in Mr Carney’s Treasury select committee appearance. But this just seems like common sense to me. The UK economy is rock solid, and the more it seems like the crisis in Greece is ending the less the risk of economic contagion to the UK economy, thus the more we should judge the UK economy on its own strong domestic fundamentals.
The issues for the Bank of England and Federal Reserve are identical. Solid economic performance but wage growth is some way behind where one might expect at this stage of the cycle. But… normalising interest rates is an important step towards moving on from the Global Financial Crisis. There are huge distortions in the global economy, and policy makers do themselves no favours by maintaining the status quo when it is not necessary anymore. This is why we continue to anticipate USD and GBP appreciation versus other currencies. These are the lead cycle currencies and fundamentals support strengthening. But events of the last week have shown that there is enough volatility to hijack any trend. It might be somewhat delayed but the path ahead is clear…
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