News of the week summary - 07/07/2024
🇬🇧Keir Starmer becomes UK prime minister
Keir Starmer has been elected as the new Prime Minister of the United Kingdom following a landslide win by the Labour Party. Starmer appointed Rachel Reeves as the first female Chancellor of the Exchequer. Reeves has pledged to prioritize economic growth and stability, aiming to spearhead a new industrial strategy that supports long-term prosperity.
The election dynamics were shaped by a significant shift in voter sentiment. Labour's triumph was facilitated by a split in the right-wing vote, with Nigel Farage's Reform UK drawing votes away from the Conservatives. This led to the Conservatives suffering their worst defeat, securing only 121 seats. Voter turnout was around 60%, near a record low, indicating widespread public dissatisfaction with mainstream politics.
Starmer's pro-business stance has been well-received by markets, particularly his commitment to building 1.5 million homes over the next five years, which he believes will be critical in healing the wounds of public disillusionment with politics.
This initiative has already positively impacted the stock prices of housing companies. Despite the electoral success, Starmer is acutely aware of the need to rebuild trust between the public and politicians. He emphasized that this trust can only be restored through actions, not just words, underscoring his commitment to tangible results.
The aftermath of the election saw former Prime Minister Rishi Sunak resign, acknowledging the public's desire for change and accepting responsibility for the Conservative Party's defeat. The Conservative collapse was partly attributed to internal divisions and the brief, turbulent premiership of Liz Truss. The Liberal Democrats also saw significant gains, winning 71 seats, their best performance in modern times.
📉Political uncertainty raises concerns over French government bonds
The prospect of unstable politics, coupled with sluggish economic growth and an increasing debt burden, has led to fears that France's bond market might start to resemble Italy's, where borrowing costs are consistently high. Since President Emmanuel Macron called for a snap election, the yield spread between 10-year French and German bonds—a key risk indicator—has momentarily widened from 0.48 percentage points to 0.85 points. The heightened uncertainty is fueled by the strong performance of Marine Le Pen’s far-right party and the left-wing alliance in the first round of the elections, raising the specter of political deadlock or a shift away from market-friendly policies.
France’s budget deficit is forecast to be 5% of GDP next year, down slightly from this year but still one of the highest in the EU. This has already led to credit rating downgrades by rating agencies Fitch and Standard's & Poor's. Additionally, the European Commission has warned of high risks emerging from France's debt sustainability analysis, projecting the debt-to-GDP ratio to rise to about 140% by 2034.
The country’s reliance on foreign investors, particularly Japanese institutions, makes it vulnerable to shifts in market sentiment. Half of France’s government debt is held by non-residents, compared to 27% in Italy and 43% in Spain. This dependency means that any negative sentiment change could significantly impact the French bond market.
While immediate disruptions to the French bond market are seen as unlikely, the long-term outlook remains uncertain. If the country deviates from pro-growth policies, this could exacerbate fiscal issues and lead to higher borrowing costs or further credit downgrades. The broader implications could also trigger turbulence within the EU, potentially requiring intervention from the European Central Bank.
💼Slowing job market paves the way for FED rate cuts
The U.S. labor market is showing signs of slowing down, potentially setting the stage for interest rate cuts by the Federal Reserve later this year. In June, the unemployment rate rose to 4.1%, the highest since November 2021, up from 4% in May. The US economy added 206,000 jobs last month, surpassing the forecasted 190,000 jobs. However, revisions to April and May data revealed that employment in those months was 111,000 lower than initially reported, indicating a downward trend in job growth.
The non-farm payrolls report, a key indicator of economic health, highlighted this cooling trend. While June’s job growth exceeded expectations, the adjustments to previous months painted a less robust picture. May's job additions were revised down to 218,000 from 272,000, and April's were lowered to 108,000 from 165,000. These revisions suggest a moderating labor market, characterized by a high proportion of new jobs in healthcare and government sectors, cuts to temporary workers, and a weak household survey.
The resilience of the US labor market over the past two years has allowed the Federal Reserve to cautiously manage borrowing costs while combating inflation. With inflationary pressures easing, the FED is closely monitoring labor market conditions to determine the timing of potential interest rate cuts.
In response to the softer payroll data, Treasury yields dropped to their lowest levels in several months, reflecting traders' expectations of possible rate cuts. The yield on the two-year Treasury, which is sensitive to monetary policy changes, fell to a three-month low of 4.61%. Although the revised data suggests a weaker labor market than initially thought, it is not indicative of a market in free fall.
💥Violent protests against IMF-advised policies in Kenya
Kenya is grappling with significant unrest as deadly anti-tax protests sweep through the nation, highlighting public anger not just at the government, but also at international lenders like the International Monetary Fund (IMF). The protests erupted in response to a finance bill aimed at raising over $2 billion in taxes, which President William Ruto was forced to withdraw. Protesters see the IMF as a driving force behind Ruto’s austerity measures.
The situation in Kenya is not unique in Africa, where citizens in several countries are rejecting austerity measures imposed to meet the demands of multilateral lenders. In Nigeria, President Bola Tinubu’s economic policies, including cutting petrol subsidies and devaluing the currency, have sparked strikes despite a $2.25 billion World Bank loan package praised for its “critical reforms.” Former Nigerian President Olusegun Obasanjo criticized the IMF and World Bank, arguing that their solutions, though suitable for developed nations, do not work for emerging economies.
The IMF maintains that its role is to help countries prioritize and efficiently use public expenditure, considering each country's specific context to build public trust and support for necessary reforms. Supporters argue that its loans are offered at much lower interest rates than commercial loans, thus providing essential financial support to countries at risk of default. They point to debt relief initiatives, like the one for Somalia, as examples of the fund's beneficial impact. However, many Africans feel that austerity measures fail to address inequality and improve livelihoods, often leading to political instability.
In Kenya, economic frustrations have led to violent demonstrations, with 39 people killed in clashes with police. President Ruto, who inherited substantial debt from his predecessor Uhuru Kenyatta’s era of heavy borrowing, is struggling to comply with a $3.6 billion IMF bailout that requires increased revenue and reduced spending. The heavy debt burden is consuming almost 38% of Kenya’s annual revenues in interest payments, according to the World Bank.
The recent protests suggest that the Kenyan government may find it politically impossible to fully implement the IMF’s fiscal targets. This has cast doubt on Kenya’s ability to meet its financial goals, with credit rating agency Standard's & Poor's expressing skepticism about the country's prospects. Responding to the unrest, an IMF spokesperson stated that the fund's objective is to improve Kenya's economic prospects and the wellbeing of its people. Critics argue that the IMF has exacerbated the crisis and should withdraw from Kenya and Africa.
💶Eurozone inflation eases, despite high services prices
Inflation in the Eurozone has slowed to 2.5% in June, down from 2.6% in May, providing a glimmer of relief for the European Central Bank (ECB). However, policymakers remain concerned about the persistent rise in service prices, which continue to offset weaker growth in energy and food costs.
The June inflation figure aligns with economists' forecasts and follows an acceleration in May. The slowdown offers some respite to the ECB, which recently began cutting interest rates with the expectation of achieving its 2% inflation target by next year. However, the ongoing strong increases in service prices are a cause for concern. Service price growth reached 4.1% in June, matching a seven-month high set in May, according to data from the EU's statistics office, Eurostat. Economists suggest that the ECB is likely to maintain its benchmark deposit rate at 3.75% during its next meeting on July 18. The decision on future rate cuts will depend significantly on the trajectory of service inflation.
Eurostat data reveals that energy inflation decelerated from 0.3% in May to 0.2% in June, and unprocessed food prices fell from 1.8% to 1.4%. Core inflation, which excludes energy and food prices, remained unchanged at 2.9%. The start of the summer tourism season, coupled with several major sporting and cultural events, is likely to push up prices for high-demand services such as hotel rooms and airline tickets.
ECB President Christine Lagarde emphasized the need for time to assess whether inflation is truly under control, citing uncertainties around the interplay of profits, wages, and productivity, as well as potential new supply-side shocks. The Eurozone's labor market remains robust, with unemployment holding steady at a record low of 6.4% in May.
Political uncertainty in France has also been on the ECB's radar. Investors speculate that the ECB might need to intervene by purchasing French bonds if election results lead to significant market turbulence. However, the bank's Vice-President Luis de Guindos has downplayed these concerns, stating that market reactions have not been disorderly and reflect potential shifts in fiscal policy.