Troubles Anew

Though yesterday all seemed okay
Today, poor Prime Minister May
Has troubles anew
As two from her crew
Of cabinet ministers stray

As I wrote yesterday, it seemed odd to me that despite the headline news of a Brexit deal being reached, and ostensibly signed off by PM May’s cabinet, the market response was tepid, at best. Given that the Brexit story has been THE key driver of the pound for the past eighteen months, how was it that one of the biggest developments in the entire saga was met with a collective yawn by the market? One would have expected a sharp rally in the pound on the news of a Brexit deal being agreed. Instead, what we got was a pound that fell slightly after the announcement, seeming to respond to modestly softer inflation data rather than to the Brexit story.

Well, today we learned the answer to that question. The news this morning is that Brexit Minister, Dominic Raab, as well as Pensions Secretary Esther McVey, both resigned from the cabinet citing the PM’s Brexit deal. Both indicated that they could not support the deal in its current form given the relatively high probability that it will result in different treatment for Northern Ireland than for the rest of the UK, a de facto sovereign rift within the UK. While May remains in office, and there has not, as yet, been any official effort to dethrone her, it is also clear that the probability of this deal being passed by Parliament has fallen sharply. And along side that probability falling, so too has the pound fallen sharply, down 1.5% as I type. In truth, this outcome can be no real surprise given the intractable nature of the underlying problem. A nation is defined by its borders. Insisting that there be no border and yet two distinct nations has been an inherent dilemma during the entire Brexit process. One side has to concede something, and thus far neither side is willing to do so. It remains to be seen if one side does cave in. For now, however, the pound is likely to remain under pressure.

The other story on which FX traders have focused was the speech by Chairman Powell last evening, where in a subtle change in tone, he recognized potential headwinds to the US growth story. These include, slowing growth elsewhere in the world, trade friction and the lagged impact of the Fed’s own policy changes, as well as the diminishing impact of this year’s fiscal stimulus. While none of this is ‘new’ information, what is new is the communication that the Fed is paying close attention. It had seemed to some pundits that the Fed was on autopilot and ignoring the changes that were ongoing in the global economy. By his remarks, Powell made it very clear that was not the case. The market impact, however, is a belated recognition of that fact, and instead will respond to the information that they see. If financial conditions tighten sufficiently because the underlying growth situation is weaker, the Fed has made it clear they will adjust policy accordingly.

The result of these comments was a very mild softening in the dollar as traders and investors implicitly reduce the probability of further policy tightening. However, the movement has not been very significant. Since Monday’s dollar peak, it has drifted lower by about 1% in a relatively smooth manner. Certainly, yesterday’s US CPI data didn’t help the dollar as it printed slightly softer than expected. Combining that with the Powell comments has been plenty to help stop the dollar’s recent rally. The question, of course, is how will upcoming data and information impact things. At this time, the market is following a completely logical pattern whereby strong US data results in a stronger dollar and weak data the opposite. With that in mind, I would suggest that this morning’s data will be of some real importance to the FX market.

Here are expectations for today:

Initial Claims 212K
Philly Fed 20.0
Empire State Manufacturing 20.0
Retail Sales 0.5%
-ex autos 0.5%
Business Inventories 0.3%

In addition, Chairman Powell speaks again at 11:00 this morning, although it would be hard to believe that he will have something new to say versus his comments yesterday. In all, if today’s data shows signs of faltering US growth, I expect the dollar will slide a little further, whereas strong data should see the dollar retraces some of yesterday’s losses. As to the pound, absent another resignation, it has likely found a new home for now. However, it will be increasingly difficult for the pound to rally unless a new idea is formulated, or we hear soothing words from the EU. At this time, neither of those seems very likely.

Good luck
Adf