Bubble and Squeak

The pound has been buoyant of late

As progress in the key debate

Implies that next week

(O’er bubble and squeak?)

A deal just might break the stalemate


For the past month, the pound has been on a tear, rising nearly 3.0%. Expectations continue to build that a preliminary agreement over the first items in the Brexit negotiation will set the stage for opening trade discussions. Those first three items are: 1) the disposition of EU citizens living in the UK and their rights going forward; 2) the divorce bill; and 3) the eventual status of the border between Ireland and Northern Ireland. The first of these was addressed some time ago, and seems no longer to be an issue. It was at the beginning of this week when stories made the rounds about a breakthrough on the divorce bill, where ostensibly the headline number was increased substantially from the initial talk of £20 billion, but the timeline of the payout was extended so greatly that it appears the present value of the number is little changed. Which brings us to the third issue.

It appears that market participants have been pretty sanguine about the resolution of the Irish border issue, because it was not something that was getting much press. However, it may well be the most intractable problem of all. Consider that the border in question will be the only land border between the UK and the EU once Brexit has been completed. Consider also the long history of violence that exists there, and the fact that one of the key features of the Good Friday Agreement of 1998, which established the peace between the UK and Ireland, was the fact that there was no visible border left between the two nations. This worked because both sides were members of the EU and therefore part of the same trade and customs union. But Brexit will change that. This is especially problematic because PM May relies upon the votes of the Northern Irish DUP party for her majority in Parliament, and they are adamant about maintaining their sovereignty, which means they want a border. Meanwhile Ireland is adamant that no visible border should be erected. If May caves to the Irish demand, she may well lose her majority and potentially a no-confidence vote. Whatever the outcome of a new election, I assure you that the timing would not be perceived as a positive for the pound. A change in government with just fifteen months left in the Brexit timeline would be a significant problem for the process and certainly would weigh on the currency. On the flipside, if May sticks by the Northern Irish demands, then trade talks will slip further into the future, if they are to come about at all. This, definitively, would be bad for the pound given that its recent rally has been based on progress in this area. In other words, there are several compelling cases to be made that the pound is a bit overextended on the high side. Hedgers beware! While the overnight decline has been small, it would be easy to foresee a breakdown over this issue resulting in a retracement of all the recent gains and then some. I might consider some GBP options here as they remain inexpensive, especially for puts given the recent change of tone. For example, a 3-month 1.3250 put costs just over a penny.

As to the rest of the market, the overnight session can best be characterized as mixed. In the G10 space, no currency has moved more than 0.3% (NZD’s short-covering rally) while no other currency moved even 20bps. Something that has gotten a little press has been the surprising rise in EONIA fixings the past two days. This jump of 6bps each day has opened a substantial gap between the ECB’s base rate and market transactions. Given the timing, at the end of the month, my sense is that there was a short squeeze for funding at some bank, but that it is not a long-term issue. However, it does highlight the flaws in looking at market probabilities for future central bank rate activity. I would contend that there has been absolutely no change in the zero probability of a rate hike later this month by the ECB, yet if calculated off the futures markets, that number has risen to 23% because of this move. Look for it to disappear at today’s fix. However, if EONIA fixes near yesterday’s rate of -0.24% again, then something else may be afoot, and will need to be investigated.

Also demonstrating how lackluster FX has been overnight is the fact that across the 24 EMG currencies of note, none have moved more than 0.35%, with both gainers and losers about equally split. For movement that small, it is hardly worth looking for rationales. Rather, that is just part and parcel of the ordinary price activity.

Turning to the data front, yesterday’s US data showed PCE was ever so slightly firmer than expected, Personal Income and Spending were right in line and Chicago PMI fell a bit less than expected, to a still very high 63.9, from its previous reading of 66.2. Clearly, equity markets were enthused by the data as we saw a remarkably powerful rally in the Dow, taking us to new highs there. However, the story overnight that the Senate vote on a tax bill would be delayed has dented some of that enthusiasm and thus equity futures are all pointing to a lower opening this morning following European shares lower. Meanwhile, we have ISM Manufacturing data to be released at 10:00. Expectations are for a print of 58.3, with the Prices Paid index coming at 67.0. This would highlight continued robust performance from the manufacturing sector in the US. The Eurozone data released this morning showed strength continues there as well, which means global growth remains in solid shape at this time.

As to the future of the dollar, other than the pound, which I feel has gotten way ahead of itself, it is hard to make the case for significant movement without a new catalyst. That could be finalized tax legislation, a breakdown in equity markets, or more likely, something that we would not even consider important at this time. Remember this though, nothing matters to markets until it MATTERS to markets. Highlighting the current keys doesn’t necessarily tell us about what will drive things in the future. And that is why FX markets, in particular, seem so perverse.


Good luck and good weekend