Brexit means fudge

Brexiteer-in-chief David Davis has resigned in protest of the soft Brexit strategy revealed by the Prime Minister at the weekend. 

Theresa May outlined her “third way” at a fractious Cabinet conference at the Chequers country estate on Friday. Her plan is to aim for a sort of Norway-lite: part of the European Economic Area and trading bloc, but with some opt outs for justice, immigration and regulation. Essentially, it would mean the UK would have to simply obey many European rules without having any say in their creation. In return the UK would have access to the Continental market tariff-free.

Brexiteers are upset because it’s not really a Brexit at all. Europeans are upset because it appears that the UK is trying to pick and choose which rules it will and won’t follow. Remainers are upset because the UK is simply giving up a commanding seat at the EU table for a complicated patchwork that leaves things virtually as they were. The only thing all can agree with is that this is a rather large fudge.

Mr Davis resigned because he didn’t believe in the plan and said he would struggle to sell it to European leaders. A couple of other ministers resigned along with him and at least one Conservative MP has called for Mrs May’s head. Jacob Rees-Mogg, a perennial yet unlikely challenger of Mrs May, has been stoking this discontent and has pledged to fight the announced plan. As it is, it appears that Mrs May should be able to totter on. There are just no enticing alternatives for the ruling party to get behind. Dominic Raab, a lawyer, will give up his Housing portfolio to replace Mr David as Brexit Secretary, meaning the Cabinet’s leave-remain balance remains as it was.

At risk of sounding like a broken record, we still believe that Brexit means sterling. The currency will be the best barometer for the progress and quality of Brexit plans. The pound should strengthen with improving chances for a better deal (for business) and fall when things are looking less rosy. Over the past week to this morning, sterling is about 1%.

Source: FE Analytics, data sterling total return to 6 July

Who wins from tariffs?

Politics aside, the UK had a reasonably good week for economic news.

PMIs, measures of confidence and output, were stronger across all parts of the economy. The Halifax House Price Index showed the fall in house prices appeared to be slowing. No doubt the combination of a heatwave and football has boosted confidence around the country as well. Market expectations of a 25-basis-point interest rate hike in August continued to rise and are now floating around an 80% probability.

The US has also been rolling along soundly. Despite President Donald Trump’s bombastic tweets and tariff threats – several of which are now in force – the nation’s economy and stock market have hardly flinched at all. Both are still incredibly strong. The same can’t be said for China, however.

On Friday, $34 billion of US imports from China were subjected to a 25% tariff, with a further $16bn subject to a 25% tariff starting in a fortnight. China confirmed a reciprocal tariff on a set of its imports from the US, meaning Mr Trump will look to make an additional $200bn of imports subject to tariffs over the coming months, and an additional $300bn after that.

Mr Trump always said that America could withstand a trade war easier than most thought. As of the moment, that appears correct. Mr Trump’s thinking is: China exports so much more to the US than it receives so any drop in trade between the two will hit China harder. This is too simplistic because many American manufacturers and households depend on Chinese-made goods that will now cost more or simply disappear from the shelves and warehouses. Of course, this effect is less visible than an exporting firm suddenly shedding a few hundred million of market cap and a few thousand workers.

As things stand, the first $34bn of tariffs would have a negligible impact to the GDP of both nations. Even if the additional $200bn of tariffs are added, it would still be relatively small in effect: $250bn is about 8.5% of total US imports. We don’t believe this tit-for-tat exchange will lead to a recession in the West or the East.

As for China, its currency has taken a pretty hefty step downward recently, especially given it’s pegged. The Shanghai Stock Exchange Composite is down almost 20% over the past six months. China is carefully trying to deflate a balloon of debt that has expanded throughout its economy, from property to the stock market. A trade war adds another level of fragility that the nation’s leadership would probably rather avoid.

Still, while this may mean it’s a good time for Mr Trump to win a few concessions and settle down back to the status quo, underestimating China’s strength could be extremely dangerous. The country’s levers of power are concentrated and refined. The renminbi has fallen in value because the leaders wanted it to. The stock market fell because the leaders decided to not simply freeze trading. There are even reports that censors have told journalists that they shouldn’t connect the market falls to the trade war in their reporting. In the meantime, China appears to be playing a much longer game. A ban on UK beef was lifted last month and just last week China reduced tariffs on thousands of Indian goods.

By phasing the US out of its trade market and pivoting to other countries it could erode the global clout of an increasingly insular America.

Bonds

UK 10-Year yield @ 1.27%
US 10-Year yield @ 2.82%
Germany 10-Year yield @ 0.29%
Italy 10-Year yield @ 2.71% 
Spain 10-Year yield @ 1.31%
 

Economic data and companies reporting for week commencing 9 July

Monday 9 July

US: Consumer Credit 
EU: GER: Balance of Trade, Current Account

Final results: Abbey

Tuesday 10 July

UK: Balance of Trade, Industrial Production, Manufacturing Production
EU: ZEW Survey Economic Sentiment

Final results: Begbies Traynor Group
Trading update: Dechra Pharmaceuticals, ITE Group, Kier Group, Marks & Spencer Group, Robert Walters plc (RWA), Young & Co's Brewery
Interim results: Ocado Group

Wednesday 11 July

US: MBA Mortgage Applications, Producer Price Index, Wholesales Inventories, Crude Oil Inventories

Final results: Micro Focus International
Interim results: Low & Bonar 
Trading update: Barratt Developments, Burberry Group, Hotel Chocolat Group, J D Wetherspoon, PageGroup

Thursday 12 July

US: Consumer Price Index, Continuing Claims, Initial Jobless Claims
EU: Industrial Production; GER: Consumer Price Index

Final results: Dart Group
Trading updates: ASOS, Dunelm Group, Hays, Premier Oil, Ten Entertainment Group 

Friday 13 July

US: Import and Export Price Indices, University of Michigan Confidence (Prelim)

Final results: Hays
Trading update: Experian