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Four hikes now likely in 2018

Jay Powell the new Chairman of the Federal Reserve delivered an upbeat message on the U.S. economy yesterday and drove market expectations that interest rates will be raised four times in 2018.

Mr. Powell’s words sent shivers through the global stock markets as the JPY confirmed its safe haven status in times of risk aversion.

Powell has already gained a reputation as not talking simply to tell Wall Street what they want to hear. His words pushed the DJI down by 300 points on Tuesday and he is unlikely to moderate his tone during his second testimony today.

The dollar’s rise coincided with falls in both the pound and Euro each reacting to their own drivers. The dollar index has been making new lows all year as concerns about the U.S’ twin deficits start to concern markets. With tax cuts and infrastructure spending set to send the budget deficit through one trillion dollars and the trade position continues to worsen.

A rate hike in May is now 100% priced in and while three hikes remains the base case, Powell’s sense of realism has led traders to see a fourth as a genuine possibility.

Brussels Draft Brexit Treaty widens rift

Any short term hopes for a soft Brexit were dashed yesterday as the EU published their first draft of the Brexit Treaty. Several issues were left hanging in the air, not least of all the future trade agreement which wasn’t mentioned at all, but it is the Irish border issue that has caused the most immediate concern. As Brussels proposals stand, Northern Ireland will be left high and dry as a member of the customs union with a border running north to south down the Irish Sea.

Theresa May the UK Prime Minister met the issue head on saying that it was a proposal that no Government could sign. Mrs May, tied to the DUP by her reliance upon them to support her Government received a blow from inside her Cabinet from Foreign Secretary Boris Johnson who said in a memo that Brexit should ensure not the Irish border should not become harder rather than remaining exactly as it is.

The pound fell back close to its lowest level this year as the reality of a hard Brexit and Brussels immovable attitude were illustrated perfectly.

Brussels attitude remains unchanged. The UK voted to leave the EU and it is not Brussels responsibility to make such a move palatable. A long period of negotiations now starts with the Mrs May seemingly being forced closer and closer to a hard Brexit.

EU inflation fall pushes Euro lower.

Eurozone inflation has long been the battleground on which the ECB and Bundesbank fight their contrasting view on proactivity.

The ECB is of the view that until inflation starts to rise significantly and starts to threaten their 2% target they can keep interest rates low which benefits the economy and its rise away from the debt crisis which threatened to engulf it at the start of the decade. They see the Eurozone economy as something of a work in progress given that there are no tried and tested models that bring together nineteen such diverse economies under a single monetary policy.

The Bundesbank is more used to pre-emptive action and raising rates as a precaution to ensure they stay ahead of the curve. Jens Weidmann, the Bundesbank President has been calling for a rate hike as his analyst’s models are predicting an overshoot in inflation towards the end of the year although yesterday’s fall in January’s inflation figure contradicts his view. With Weidmann’s grip on the ECB Presidency being prised apart by the European Council who favour the appointment of the President of the Banque de France, Bundesbank influence over the ECB may be waning.

 

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