In Twenty-sixteen when we learned
That Britain, the EU, had spurned
The pound took a fall
While casting a pall
On how future growth might be earned
For nearly two years chaos reigned
While Brexiteers strongly maintained
A deal will be made
With no one betrayed
And there is still much to be gained
Well last night it seems that both sides
Have finally made some real strides
It’s no real surprise
To see the pound rise
As delegates closed the divides
The big story this morning is that there seemed to be real movement in the Brexit negotiations with an agreement “95% complete” according to the UK government. The key was an agreement regarding financial services, obviously an enormous issue for the UK, whereby UK financial firms would still be given access to the EU based on the “equivalence” of regulations. While this is not quite as robust as the current situation, being within the bloc, it is seen as sufficient to allow continued cross border access in both directions. Of course, the Irish border situation remains outstanding, but there is talk that progress has been made there and that the benefit of a finance deal will be sufficient to offset hard-line concerns over Ireland.
The market response was immediate with the pound jumping more than 1.0% when the headlines hit. If a Brexit deal is reached, the pound likely has further to rise as there is no question it has suffered based on the increasing likelihood of a no-deal situation. That said, a full-throated rally seems unlikely. There are still many other issues that are going to weigh on the pound, notably the dollar’s underlying strength as well as UK economic malaise. In fact, data early this morning showed that the UK manufacturing PMI fell much more than expected to a reading of just 51.1, its lowest reading since the month after the Brexit vote. Obviously, this data did not include the positive news from today, but it is indicative of how the UK economy continues to slow along with the rest of the world. If a deal is signed, I expect the pound could rally another few percent, but anything more than 1.35 would seem to be a stretch based on the economic fundamentals.
But the Brexit story set the tone for the FX market as the dollar is softer across the board, in many other cases having fallen by more than 1% as well. For example, the euro has rallied by 0.6% amid general enthusiasm generated by yesterday’s global stock rebound. We have also seen both Aussie (+1.1%) and Kiwi (+1.4%) jump sharply, as commodity prices stabilize and risk appetite improves.
This theme was also made evident by movements in government bonds around the world, where, for example, Treasury yields are 10bps higher over the last two sessions. In addition, EMG currencies, which had a terrible month in October, have shown some life this morning. Today we see the Mexican peso has rallied 0.8%, while South Africa’s rand is up 1.5%. Even the Chinese yuan, which has been closely scrutinized due to its approaching the critical 7.00 level, has rallied today by 0.4%, its largest gain in more than three weeks. In fact, most EMG currencies are higher, with many gaining more than 0.5%. In other words, it has been a broad-based USD decline. After a strong multi-week run in the dollar, it can be no surprise that a correction has occurred.
Turning to the data situation, yesterday’s ADP number was quite strong, 227K, and the Employment Cost Index (ECI) showed that wages are rising at a 3.1% clip Y/Y, the fastest in several years. While yesterday’s Chicago PMI disappointed slightly at 58.4, that remains a very firm reading historically. Looking forward to today’s session, we hear from the BOE, where policy is forecast to be unchanged, and we will get updated economic forecasts. If a Brexit deal is signed, look for the UK to raise rates several more times next year as there should be a positive growth impact. Then from the US we see Initial Claims (exp 213K), Nonfarm Productivity (2.2%), Unit Labor Costs (1.0%) and ISM Manufacturing (59.0). While these will be seen as important, tomorrow’s payroll data is still going to be the focus, especially the Average Hourly Earnings (AHE) number. With the ECI pointing higher, if AHE shows the same thing, watch for more talk of the Fed becoming even more aggressive.
Ultimately, the US data picture continues to point to strength in the US economy, especially relative to what we are seeing throughout the rest of the world. The EU is slowing, the UK is slowing, China is slowing and so are most other places. As long as this remains the situation, it is hard to expect the dollar to retreat in any meaningful way. While no market moves in a straight line, the dollar’s trend remains higher.