Article last updated 30 September 2025.
The government has got itself in another tangle over Brexit. Meanwhile, chief investment officer Julian Chillingworth investigates the strange dichotomy that’s driving an ascendant dollar.
The UK has had a tough start to the year. And yet, the FTSE 100 posted its best quarterly return in 15 years in the three months to 30 June.
In early July, the Cabinet was ripped apart by disagreement over Theresa May’s “third way” Brexit strategy, unveiled at the Chequers country estate. 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. Several senior ministers – including Brexit secretary David Davis – resigned and there were even calls for a second referendum from the Prime Minister’s own benches.
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.
Economically speaking, June was relatively ok for Britain. A run of sunny weather and a spirited run by the England team in the World Cup created a bit of optimism – something that has been in short supply. PMIs, a measure of business confidence and output, rose across all parts of the economy. Retail spending growth was up substantially in May, but undershot in June. Wage growth slowed, however, from 2.6% to 2.5%. Also, economic growth has been poor lately with the UK posting just 1.2%, even lower than “basket case” Italy (1.4%).
UK Inflation undershot expectations in June. It remained flat at 2.4% for the third consecutive month instead of rising to 2.6% as forecast. The probability of the Bank of England (BoE) hiking interest rates by 25 basis points in August was unaffected though, and remains at about 85%, according to interest rate swaps. Still, we have been here before. A May rate hike by the Bank of England was all but locked in at the beginning of April; however, UK growth slowed to a crawl, inflation eased and retail sales slumped. The rate hike most expected was swiftly shelved.
We will just have to wait and see whether BoE Governor Mark Carney pulls the trigger or shies away once more.
Source: FE Analytics, data sterling total return to 30 June
Green-backed rocket
The dollar soared higher in the second quarter, easily reversing a first-quarter slump. The world’s reserve currency jumped 5% against a basket of trading partners as its economy steamed ahead.
American vital signs were extremely healthy last month. Consumer and business confidence is brimming over, retail spending posted strong annual gains and the housing market is still improving, potentially offering another leg to the country’s growth. All this activity has been stoking inflation: US CPI has been rising steadily from 2.1% at the beginning of the year to 2.9% in June. The US Federal Reserve has stepped up the pace of its interest rate hikes in response and is on track to raise interest rates four times in 2018. This has helped drive the dollar higher. Another factor pushing the greenback higher is increased anxiety about a budding trade war between the US and, well, the world.
The reason trade risks are helping buoy the dollar, even though the US is the instigator, is because unravelling globalisation could puncture global growth. If that happens, businesses would find it harder to hit their earnings targets, lowering the value of both equities and riskier bonds. Emerging markets are seen as particularly vulnerable to a slowdown in global trade because they are typically heavily aligned to export business. As risks rise for these investments, investors tend to sell and flee to the safety of US treasuries. To do that, you need to convert your cash to dollars to buy them; more demand for dollars sends the price of dollars up, just like if you were dealing with apples or oil. In July, the Bank of America Merrill Lynch Fund Manager Survey showed the feelings on equities turned negative for the first time since early 2016. This seems to reinforce that investors are shying away from risk right now.
On the other side of the coin, the renminbi fell sharply last month. This was probably as much a driver of dollar strength as the dollar strength was a weight on renminbi. The offshore market for renminbi dropped 3.5% in June and had weakened almost 5% to mid-July. There is always a suspicion that China is actively devaluing the renminbi to get an edge over its trading partners; in truth the central bank was actually selling dollars aggressively in a bid to mitigate the renminbi’s falls. In some ways the drop in the currency was simply the market catching up with what the value should be. It was probably triggered by China’s central bank loosening monetary policy and the conversion of trade threats into actual tariffs. The tariffs have definitely hurt Chinese stocks, with the Shanghai Stock Exchange Composite down 10% in June.
Another influence on the currency may have been that China’s current account – exports less imports – fell into deficit in the first quarter, something that hasn’t happened since 2001. However, that news came out in May, more than a month before the slump in the Chinese currency.
This about face in China’s current account is less worrying than it may seem. Wobbles in global trade reduced the demand for worldwide exports in the first quarter (Chinese exports are typically lower at the start of the year, too), but Chinese demand for imports held up better than other nations. Also, we have talked about the sea change in China’s economy many times: as the nation’s middle class grows, it is becoming much more focused on the services and technology companies of the ‘New China’. The heavy industry and low-value exports that powered the gargantuan trade surpluses are part of the ‘Old China’ that is beginning to fall by the wayside. We see this as a good thing for China and the global economy.
Bond Yields
Source: Bloomberg
Julian Chilingworth, Chief Investment Officer