As the global economy gained steam in Q2 through Q4 last year in a more synchronized fashion, the UK seemed to be only major economy that was getting left behind. Firms have opening offices and shifted workers into the EU, real estate prices are under pressure, and the initial competitive boost of sterling weakness has faded as the currency stabilized. Two years in, the economic fall-out of the referendum is clearly being felt. Moreover, with only a provisional agreement on the transition period, and virtually no progress on other important issues like financial services or the Irish border, the UK is at risk of stagnating even further.

While the journey toward withdrawal remains in progress, some clear lessons have emerged in the negotiating process that might help Britain in the latter stages – or at least serve as a cautionary tale to the remaining EU members contemplating life outside the union. One, have a clear objective entering the process. Throughout the negotiation, the UK goals have vacillated too frequently between getting a good deal, avoiding a bad deal, or a compromise withdrawal deal that might have rendered the vote meaningless. To paraphrase Seneca, no wind is favorable if you don’t know which port you’re sailing to. Two, present a unified front.

Undoubtedly, the UK’s position in these negotiations has been weakened by infighting: Leave vs. Remain, Tory vs. Labor, Tory vs. Tory, Lords vs. Commons. Prime Minister May has been fighting with both hands tied. Third, know your line-in-the-sand. Without a real willingness to walk away, you have little credibility in the eyes of your counterparty. Hard Brexiteers were willing to accept those painful consequences (and may still get the chance), but constant backsliding by the UK has emboldened EU negotiators. The UK’s unclear withdrawal strategy has created uncertainty, and that uncertainty ultimately has real downside economic consequences.

Philippe Waechter, Chief Economist, Ostrum Asset Management

The most striking impact of the Brexit is the lower growth momentum seen in the UK since the referendum. The dynamics has faltered and the UK has not taken advantage of the strong growth improvement of the Euro Area in 2017.

A very simple calculation can translate this remark. I have calculated a trend on the real GDP level from the beginning of the recovery in 2013 to the second quarter of 2016 (referendum) and extended it to the first quarter of 2018. I did the same for France, Germany and the Euro Area. In the first quarter of 2018, the French GDP is 1.8% above its trend, Germany is +1% and the Euro Area +1.4% while the UK is 2% below it.

The UK is disconnected from the rest of Europe while the Euro Area is its main trade partner. In other words, despite the European recovery there was no positive contagion to the UK.

Expectations about the UK have dramatically changed and the domestic market is not strong enough to drive a strong growth trajectory. The uncertainty will remain, implying less capital inflows, people outflows leading to lower human capital and lower capital expenditures. The adjustment process is just at its beginning.

It means that the Bank of England will not rapidly normalize its monetary policy. The inflation rate is converging to the BoE target at 2% and the economic momentum is low. Taking the risk of a normalization would be another source of weakness for the UK.

The main effort is to reduce uncertainty for everyone, from households to companies and foreign investors. That would be key for a recovery. But the current negotiation with the European Commission and the weakness of Theresa May and her Parliament do not remove the risk of a hard Brexit and a situation that would have a persistent negative impact on the UK economy.

By Dave Lafferty, Chief Market Strategist

The post Brexit was so 2016 appeared first on AdviserVoice.

Philippe Waechter

Growth has made a comeback but each country already wants to take its own path. Unity is no longer on the cards and the world economy is fast going down a very different road.

During the recovery in 2016 and 2017, the worldwide situation was relatively stable, with no major imbalances, and the central banks cut some slack when required to make it through any bumpy patches. This approach worked fairly well as the pace across the various areas of the world became more uniform, driving growth and trade momentum, and economists were constantly forced to upgrade their forecasts.

Looking to China and the US

The Belt and Road Initiative (BRI) sets out a roadmap for trade with third countries and reflects the country’s desire to shape its trade initiatives as it sees fit in order to limit the risks on its own situation. The logic underpinning this program is not necessarily entirely compatible with the WTO’s approach.

This whole issue is particularly important in light of the United States’ recent decision to implement import duties on steel and aluminum with the risk of knock-on effects worldwide and the danger of fresh imbalances across the globe, especially in Europe which is the primary supplier of US steel imports. The new aspect in the current situation is that the US is now targeting countries traditionally seen as partners, so the logic behind these moves is problematic

These measures will probably lead to an increase in US steel and aluminum production as production facilities in the country are not running on full capacity, and foreign production will be more expensive.

This is actually one of Trump’s arguments: production facilities can run at higher capacity so imports should be restricted in order to promote local production. But it will not be enough to meet all US demand, and prices are poised to rise for downstream sectors in the US, while also leading to lower exports for Europe and pricing pressure for non-US steel and aluminum production, which will no longer be sold across the pond. This will dent these sectors in Europe

This US initiative is also worrisome as it seems to be just one piece of the jigsaw rather than the whole picture. The While House even seems to want to take this strategy even further, apart from for countries that request special conditions and are willing to accept the terms laid out by Washington, which is probably not good news for these countries. This strategy sees the US break with WTO practices, on the grounds that it is supporting its local business interests. This policy will merely serve to further strengthen China’s trade programs

The other aspect of the current US strategy is that it pushes growth up via very aggressive fiscal policy, amidst an economy running on full employment. Generally speaking, when unemployment is very low, the US government’s deficit decreases, which is logical as the two indicators, unemployment and the public balance, provide a reflection of the overall business cycle. The usual regularity of the chart below is set to be disrupted in 2018 by moves from the White House and Congress. Unemployment is poised to remain low but the public deficit will increase, easily rising above 5% and moving towards 5.5% or even 6% and more.

US is adopting inward-looking politics

When Reagan embarked on stimulus moves, the economy was far from full employment, unlike the situation today. So the aim of this approach is not macroeconomic, but rather a strategy to redistribute wealth towards the richest portion of the population, as shown by simulations for the 2018-2027 period, which is the initial duration of this fiscal policy.

This policy is set to shore up domestic demand and further accentuate the external trade imbalance, as already seen over recent months. Pressure will initially emerge on the US market, so we can expect increasing pressure on inflation.To avoid the fall-out from this, the Fed will have to take faster and more decisive action than expected, which means that we can envisage more rate hikes in 2018 (at least four) if it is to curb the imbalances triggered by fiscal policy.

The US economy has not displayed robust growth across the current cycle (beginning in the second quarter of 2009), but this did not trigger long-term imbalances. Growth could have ambled along for quite some time, with monetary policy safeguarding a balance between the various aspects of the cycle, but the White House took a different route, creating a shock on fiscal policy along with a shock on trade via higher customs duties. This is set to lead to higher interest rates from the Fed and a flattening yield curve, as investors will still want to believe in the Fed’s credibility and will not factor a long-term increase in inflation forecasts into long-term rates.

The other consequence is that the Fed will have to normalize monetary policy more quickly than expected, and in order to address this possibility, the ECB will not want to take the risk of informing the market when it will change its monetary strategy. Benoit Coeuré was clear on this point during his interview on French radio yesterday morning, and this reflects the ECB’s dwindling independence as its strategy now hinges on moves from the Fed.

The Fed’s strategy is set to push up the dollar over the months ahead, and the interest rate differential will end up having an impact, especially if the Fed has to step up the pace of rate hikes. Rate hikes will be faster and sharper than expected, so volatility will surge on the equity markets. There is always an 18-24-month lag between the Fed’s rate hike and the increase in volatility, so this will take us to 2019/2020.

The three large geographical areas are no longer taking a coordinated and cooperative approach. The US and China want to set their own rules for international trade, with the danger that they will move away from WTO rules and resume a bilateral strategy all round, which will not be fair for parties across the board. Meanwhile in Europe, the lack of political initiatives raises a lot of questions. Economists put forward solutions but these are just castles in the air if they do not have political support. So the momentum triggered by the recovery has now come to an end and the emergence of a new political order is leading to uncertainty on the world economy’s ability to sustain the pace of growth achieved in 2017 and 2018 so far. The crisis is not over as the political transformation is not complete.

By Philippe Waechter, Chief Economist, Natixis AM

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• “Currency would be at the very crux of the new framework that France would need to set up. The central bank would lose its independence and would be used as an instrument to finance state spending. In other words, the state would have the wherewithal to create its own currency to finance its own spending: economic history tells us that this type of situation triggers inflation and fuels macroeconomic, financial and monetary instability. French savers would be directly hit.”
• “The monetary question is the key to the difference between the French situation and the UK’s situation with Brexit. Many talk about continuity in the UK after the June 23 referendum, and see the absence of a doomsday scenario as proof that a withdrawal from the European institutions is perfectly innocuous. This view is very extreme as Brexit was only effective after the UK notified the European Union it was triggering article 50 of the Treaty of Lisbon on March 29. But this is not our point here. The point is that France’s potential withdrawal from the European institutions and the creation of a new currency go well beyond Brexit.”
• “In the event of a return to a national currency in France, the overall dynamics would be very different. There would be a macroeconomic shock that would be similar to the Brexit effect, as French companies would have greater difficulties in selling their products internationally as relationships with partners shift.”
• “So taking France out of the Eurozone is not at all comparable to Brexit. It is a much more complex process that would affect behavior across the board, creating deep uncertainty and a severe risk of instability that would affect macroeconomic momentum in the long term. All of this would push back the economy’s return to growth to a much later date.”

Read the full commentary.

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