Time is almost up for the UK and EU. Almost a year after reaching the transition agreement and many soft deadlines later, the real hard deadline on 31 December is nearing rapidly. If the two sides do not find a trade agreement by then, the UK and EU will have to trade on WTO terms, at least until they negotiate something better. At the time of writing, the fishery rights and level playing field appear to be two areas of disagreement. It is difficult to say how close to a deal the two sides are but the strengthening GBP over the past week suggests financial markets are taking a positive view. In our view, the probability of a deal is 50-50 but comments in recent days have been more positive, suggesting, at least on the margin, that a deal is more likely than not.. No deal would have large negative implications for the UK economy and the GBP, while Europe and, in particular, the global economy would feel less of an impact.
Meanwhile the vaccination process is moving forward amid second waves. Germany and The Netherlands went into new lockdowns this week and London moved to tier 3 after the virus flared up again, with Christmas looming just around the corner. Spain has also seen a new turn higher in COVID-19 cases over the past week. In the US, new cases are rising again, following the ‘false peak’ after Thanksgiving. On a positive note, this week saw the first vaccinations in the US and UK and Europe is due to follow very soon, providing vaccines to the most vulnerable groups. Further rollout of vaccines in H1 21 is extremely important for the normalisation of economic activity.
Near term, however, there are signs that the re-escalation of the COVID-19 crisis in the US is starting to take a toll on the economy (see our high frequency indicator table later in this document). US retail sales released for November contracted compared with October and new unemployment claims are ticking up. In Europe, the virus also continues to weigh on service sector activity. However, the PMI release for the euro area for November was better than expected, for both services and manufacturing. China’s economy continues to look robust in Q4, with the growth rates for industrial production and retail sales notching slightly higher in November. We still look for a peak in Q1 as stimulus and ‘catch-up effects’ start to fade.
With a still-large number of unemployed and temporary benefits running out in the US before the new year, US congress is working frantically to provide new support to the US economy. It looks as though a smaller package than envisaged of around USD750bn will be approved, leaving out some of the controversial parts, such as aid to states and local government and protection of companies against lawsuits. This week, the Fed expressed concern about the outlook for the US economy in coming months due to COVID-19 restrictions but it saw a brighter outlook in H2 21 as vaccinations are rolled out. It still signals no rate hike in coming years and is set to continue its bond buying at the current pace for a long time.
The combination of positive vaccine news, possible approval of a new US fiscal package and good macro data out of China in particular propelled risk markets higher this week. Equity markets hit another record high. The positive risk sentiment supported the EUR/USD and Nordic and emerging market currencies rallied along with market-based expectations of higher inflation.
