UK’s Deepening Crisis as Trump Threatens Powell

UK Economic Outlook and Market Volatility

The economic landscape is currently marked by uncertainty, with markets experiencing fluctuations due to a combination of political threats and economic data. One significant factor contributing to this volatility is the renewed talk of former President Donald Trump threatening to remove Federal Reserve Chair Jerome Powell. This has created a tense atmosphere in financial markets, particularly as investors weigh the implications of such a move.

In the UK, the latest inflation figures have painted a bleak picture of the economy. The headline inflation rate rose to 3.6% year-on-year, surpassing the Monetary Policy Committee’s (MPC) forecast and marking the fastest increase since January 2024. Underlying inflation also showed concerning trends, with core prices rising by 3.7% and services inflation hitting 4.7%. These figures are significantly above the Bank of England’s target and indicate a troubling direction for the economy.

Despite these grim numbers, the Bank of England is expected to proceed with a 25 basis point interest rate cut at the start of August. However, the current inflation data makes it unlikely that the BoE will abandon its “gradual and careful” policy approach or shift towards a more dovish stance. The base case remains that only two 25 basis point cuts will be implemented over the remainder of the year, likely in August and November.

The UK’s economic challenges extend beyond inflation. Unemployment is on the rise, with payrolls declining for seven consecutive months. GDP has contracted for two months in a row, and Purchasing Managers’ Index (PMI) data suggests continued weakness in the coming months. Additionally, the budget deficit is widening rapidly, and retail sales have plummeted. These factors contribute to an overall challenging economic environment.

Given the high inflation levels, the Bank of England cannot afford to implement aggressive rate cuts. Meanwhile, the Treasury is focused on addressing fiscal issues through spending cuts and tax increases. The result is a combination of tight monetary and fiscal policies, which are exacerbating the ongoing economic slowdown and keeping the UK in a cycle of stagnation. It is difficult to see a clear resolution to these issues without some form of significant market disruption, potentially leading to a crisis at the long end of the Gilt curve.

Political Threats and Market Reactions

Amid these economic concerns, the potential dismissal of Fed Chair Powell has sparked considerable market anxiety. Although there is no legal precedent for such an action, reports suggest that Trump was seen holding a letter outlining Powell’s dismissal before Republican lawmakers, although he later denied any such plan existed. The mere rumor of Powell’s removal caused significant market reactions, including a steeper Treasury yield curve, a decline in the dollar, and selling in equity markets.

Trump’s threat to dismiss Powell would be ill-advised, as the market fallout could be far more severe than what was observed during the recent speculation. Comparing the US monetary policy situation to that of Turkey is not a reassuring sign. The recent market reaction supports a bearish outlook on the US dollar, as the perception of monetary policy independence continues to erode rapidly.

Upcoming Economic Data and Events

Today’s economic calendar includes several key events that investors will be closely watching. The highlight is the latest US retail sales report, which is expected to show a modest 0.1% month-over-month increase in June, rebounding from a 0.9% decline in May. The control group metric, which is crucial for GDP calculations, is anticipated to rise by 0.3% month-over-month, following a 0.4% increase in the previous period.

Additionally, the Philadelphia Fed manufacturing survey and the weekly jobless claims report will be released today. The initial claims data coincides with the survey week for the July jobs report, making it an important indicator of labor market health.

In the UK, the latest labor market report is expected to show unemployment remaining steady at 4.6% for the three months ending in May. Earnings pressures are easing, but payrolls are projected to decline for the eighth consecutive month in June. The final reading on June eurozone inflation is also expected to remain unchanged at 2.0% year-on-year.

Several central bank officials, including members of the Federal Reserve and European Central Bank, will speak today, adding to the busy schedule. Notable earnings reports from companies like Pepsico and Netflix are also expected, with options tied to Netflix pricing a potential move of +/-6.5% in after-market trading.