Silly season

You can tell its mid-summer. An ex-leader of the Tory party advocating the legalising of cannabis, an England football manager dislocating his shoulder walking in the woods and the Bank of England getting hawkish again on interest rates. It does make you wonder what the source is of the smoke signals coming out of the Old Lady.

On the one hand, the government has just announced a big boost to the NHS budget (funded by higher taxes apparently) and the Defence ministry is feeling sufficiently emboldened to seek funding above the 2% NATO minimum commitment. The mood music has changed and austerity is over.

But then there is the car crash that is Brexit. Airbus has just warned it could pull out of the UK, close on the heels of Dixons Carphone issuing a profits warning citing the difficult macro outlook for the economy. The EU and the UK seem further apart than ever with even security now being used as a bargaining tool.

Yet the Bank of England, or at least three members of the MPC, clearly feel the outlook is buoyant and we should add monetary tightening to fiscal tightening and an economy with slowing growth and a political class in turmoil.

So let’s enter the ivory tower and try to determine the strategy at play. Should rates rise to support sterling through the uncertainty caused by Brexit? Maybe. But to be honest, fingers and dykes come to mind. Or is it…well, the US is raising rates as part of normalisation and we want to be part of the club so bad it is worth the risk? Hmm… As I found out during my recent trip to Trumpland, the economy is roaring ahead and they have had fiscal easing  – note, not tightening!

So I have to conclude: Warning; chance of imminent central bank policy error high.

The impact on sterling is a huge cause for concern. We have been fully hedged out of the euro, Australian dollar and yen, and 50% hedged out of our US dollar positions. This was based on our view that sterling is undervalued and that the UK would get a deal of some sort with the EU.

In a July blog last year (Smart Brexit), and again in my end of the year blog, I predicted a second referendum (much hilarity met this). I am now feeling more confident than ever in this. Both main political parties are so divided on this issue a second referendum on a deal / no deal ticket could actually save both May and Corbyn. Remember, Remainers dominate parliament. If there is a sniff that public opinion has shifted towards remaining, it could save many political careers and get politics back to normal. Huge sighs all round.

A second referendum and a ‘Remain’ win leading the polls could see a big recovery in sterling, however the short term now seems very binary to me. A hard Brexit or second referendum. A hard Brexit could see sterling fall substantially further than it has so far since the vote to leave. A huge dilemma for us. So we keep the hedge on the Aussie and euro, reduce the US dollar hedge to 40% and take off the yen.  Well this week anyway. I suspect this could change weekly over the next few months.

I forecasted a Panama win over England this past weekend (well I am Welsh). Forecasting a win from a team more comfortable in the Isthmian Northern League was a brave call, but I think it’s a less brave call than that made by the three hawks on the MPC. What some might call bravery isn’t always a virtue, as anyone who recalls Sir Humphrey will know. Generation Z readers will find him on YouTube.