Brexit: New and improved?

Brexit: New and improved?

The UK went to Europe with a newly humble brief; US home buyers emerged in force to confront insufficient demand; The Fed's hawks are still on the wing

“I’m not in a frame of mind to make concessions. The U.K. has decided to leave the E.U. It’s not the other way around.”
Michel Barnier, European Union's chief Brexit negotiator

Brexit: New and improved? One year after the Brexit referendum, the beginning of formal negotiations demonstrated the country's newly weakened hand – and more centrist agenda. The first major concession: agreeing to the EU's two-phase timing proposal for settling on terms of the divorce, setting a badly-needed positive tone at the beginning of the formal talks, but underscoring the shift in relative power between the parties.

Rather than proposing outright revocation of EU citizens' ability to stay and work in the UK, the country’s revised plan would establish a three-tier arrangement, favoring people who had lived and worked in the UK for five years or longer, with more restrictive rights and requirements for others. This was a far cry from more extreme proposals originally floated by hard-core Brexit supporters. The change could reflect Prime Minister May's need to shore up her post-election political support as she negotiates for a ruling coalition.  But there’s also little doubt that the weakening UK economy has increased the pressure to find terms that might help the EU leave as many business interests and organizations as possible in London after the breakup.

Also at play: UK economic and market news faltered in recent days; despite the strengthening of UK manufacturing demand and bulging order books due to the continued weakness of the British pound, manufacturing costs have also spiked due to the currency's fall. That's hardly a surprise; sterling has continued its post-referendum weakness vs. the euro, down some 13% since its pre-referendum value of €1.307, reaching  €1.138 as of Friday, June 23.1

US housing prices: Solid demand, reluctant supply Sales of existing homes rose 1.1%, reaching an annualized rate of 5.62 million units in May, according to data from the National Association of Realtors. Homes sold in an average of 27 days, fastest since 2011, down from 29 days in April. The increase reflects some positive factors (slow but steady wage growth and continued softness in mortgage interest rates). However, its strength is all the more surprising given a continued decline in inventory of available properties – down 8.4% from May 2016, the 24th straight year-over-year decline. Not only that, but construction starts for new homes have declined for three months in a row and sales for new homes, about 10% of the overall market, fell 11% in April.

The Fed: Hawks at rest? After the Federal Open Market Committee (FOMC) raised its target rates in June, expectations for additional hikes for the remainder of the year have fallen rapidly. Prices in the fed funds futures market currently imply the odds of a hike to be below 50% until the FOMC's meeting in March of 2018.  That's substantially lower than the signals from Fed officials earlier in the year that as many as four hikes could take place in 2017 (there have been two so far).

The difference of opinion is grounded in stubbornly low price inflation, which has stayed below the Fed's desired longer-term goal of 2%. There are four FOMC meetings left in 2017, and the Fed has stuck to its guns so far in public about wanting to raise rates; markets appear to be making their own odds based on economic data rather than on the Fed's own statements. Time will tell whether the markets are prescient or off the mark.



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