To-ing and Fro-ing

Momentum in Europe keeps slowing
Though British results show it’s growing
The market’s response
Evoked nonchalance
Resulting in to-ing and fro-ing

This morning is one where there is not very much new to discuss. The big picture stories remain in place and little changed. So Italy is still Italy and its new populist government seems assured of being confirmed by the Italian parliament today, but policy changes remain a future concern, not a present one. The global trade situation remains fraught as the US continues to try to pressure other countries to adjust their trade terms, although so far, there has been precious little movement on this front either. And all the other big background stories (Turkey, Argentina, North Korea) continue to grind on with no new information.

In fact, the biggest market news today has been the better than expected UK Services PMI and Retail Sales data, with the former printing at 54.0 and the latter showing a 4.1% jump according to the British Retail Consortium, it’s largest rise since January 2014. It should be no surprise that the pound rallied on the news, and it is the top performer of the session, currently higher by 0.5%. The futures market also increased the probability of a BOE rate hike in August back toward 40%, from its recent depths of 30%, although I would argue that is not nearly high enough to force the BOE’s hand.

Speaking of the BOE, the key question is, will they really consider raising rates come August? I continue to believe the answer to that is ‘No’, and here is why. On the positive side, today’s data was certainly encouraging, but given the Q1 performance of GDP growing just 0.1%, the data really has to point to significant growth. We will need to see a continuous stream of data that shows UK GDP growth is heading back toward 0.5% or more per quarter in order to exorcise those Q1 demons. That seems a tall order, especially given that the UK’s largest export market, the EU, is having growth issues of its own. But that also points to the other key issue, and the one which I believe will prevent the BOE from moving, Brexit. With a shade over nine months until the UK is scheduled to exit the EU, there has been remarkably little agreement on what the future relationship between the two will look like. The EU has essentially offered the UK the opportunity to remain part of the Customs Union, continue paying into the EU budget, and retain access for UK companies in a manner similar to the situation before Brexit. Of course, that is not very attractive to the Brexiteers. The problem is that the UK has not put forth any concrete proposals as to how to create a workable exit without a complete reversion to WTO rules and no special deals. Every economic analysis shows that a hard Brexit will result in a more significant slowdown in the UK, one where raising rates would be deemed a clear policy error. When adding it all up, it seems far easier for the BOE to remain on the sidelines until there is clarity on Brexit rather than raising rates now and being forced to reverse course in the event things turn out badly. This is especially true given that their sole mandate, inflation, continues to decline and is now only modestly above target. It strikes me that a pound rally based on higher UK rates seems unlikely for now.

The other data of note was the Eurozone PMI data, which showed a continuing slowdown in the economy there. All indications are that the Eurozone saw peak growth in Q4 2017, and that since then, the Continent has been easing back. While recent political turmoil in Italy, and arguably Spain, has probably not helped, this slowdown has been ongoing since well before those situations flared up. Slowing Eurozone growth should continue to undermine any euro rally as it will simply make it that much harder for the ECB to justify tighter monetary policy. In fact, it seems more and more likely at this point that the ECB will not even reduce QE in September, but instead will delay any changes until early 2019. And that will not help the euro.

Apart from these two currencies, the G10 space has been quite dull, with today’s movement hovering in the 0.1%-0.2% range. However, we have seen a sharp move south of the border, with MXN falling 0.75% this morning following a sharp 1.0% decline yesterday. The story here continues to revolve around both NAFTA, which has started to look less likely to get renewed, and the upcoming presidential election, where Andrews Manuel Lopez Obrador (AMLO) is leading the polls by 18% and is now believed to have majority support. This means that the opposition will be unable to prevent some of his worst tendencies, and the nation’s fiscal credibility, to the extent it has any, will be called into further question. My take is that the peso has further to fall as this combination of issues will be too hard for something as mundane as higher interest rates to overcome. Investors will be loath to invest in Mexico if the new regime talks of nationalizing energy assets and other foreign investment. In fact, I would expect the peso could fall far more sharply, especially if the election outcome removes the oppositions voice in policy.

But away from Mexico, even the EMG bloc is relatively quiet this morning, with nothing new in ongoing stories and no new stories to note. As to the US session today, we have ISM Non-Manufacturing released at 10:00 (exp 58.0) and the JOLTS Jobs report (6.543M) at the same time. Certainly, the former will be watched closely, especially given the dearth of news that has been released lately, but my sense is that the market is unlikely to react significantly to the data. Rather, today is setting up to be a pretty dull session. As I wrote yesterday, until the FOMC next week, it is difficult right now to see a good reason for significant movement.

Good luck