Twixt Trade Adversaries

A fortnight from now we will know
How Brexit is going to go
Can Minister May
Still carry the day?
Or will the vote, chaos, bestow?

Meanwhile, this week, in Buenos Aires
A meeting twixt trade adversaries
Has hopes running high
We’ll soon wave goodbye
To tariffs and their corollaries

The first thing you notice this morning in the FX markets is that the pound is under more pressure. As I type, it is lower by 0.7% as the flow of news from London is that the Brexit deal is destined to fail in Parliament. Perhaps the most damning words were from the DUP (the small Northern Irish party helping support PM May’s government), which indicated that they would not support the deal as constructed under any circumstances. At the same time, numerous Tories have been saying the same thing, and the general feeling is that there is only a small chance that PM May will be able to prevail. We have discussed the market reaction in the event of no deal, and nothing has changed in my view. In other words, if the Brexit deal is defeated in parliament in two weeks’ time, look for the pound to fall much further. In fact, it is reasonable to consider a move toward 1.20 in the very short term. Between now and the vote, I expect that the pound will be subject to every headline which discusses the potential vote outcome, but unless some of those headlines start to point to a yes vote, the pound is going to remain under pressure consistently.

Beyond Brexit, there are two other things that have the markets’ collective attention, Fed Chairman Powell’s speech tomorrow, and the meeting between Presidents Trump and Xi on Friday in Buenos Aires at the G20 gathering.

As to the first, the market narrative has evolved to the point where expectations for the Fed to raise rates at their December meeting remain quite high, but there are now many questions about the 2019 rate path. If you recall, after the September FOMC meeting, the consensus was moving toward four rate hikes next year. However, since then, the data has been somewhat less robust, with both production and inflation numbers moderating. Notably, the housing market has been faltering despite the lowest unemployment rate in more than 40 years. Ignoring the President’s periodic complaints about the Fed raising rates, the data story has clearly started to plateau, at least, if not roll over, and the Fed is quite aware of this fact. (Anecdotally, the fact that GM is shuttering 5 plants and laying off 15,000 workers is also not going to help the Fed’s view on the economy.) This is why all eyes will be on Powell tomorrow, to see if he softens his stance on the Fed’s expectations. Already the futures market has priced out one full rate hike for next year, and given there is still more than two weeks before the Fed meets again, Powell’s comments tomorrow, along with vice chairman Clarida today and NY Fed President Williams on Friday are going to be seen as quite critical in gauging the current Fed outlook. Any more dovishness will almost certainly be followed by a weakening dollar and rising equity markets. But if the tone comes across as hawkish, look for the current broad trends of equity weakness and dollar strength to continue.

And finally, we must give a nod to the other elephant in the room, the meeting between President Trump and Chinese President Xi at this weekend’s G20 meeting. Hopes are running high that the two of them will be able to agree to enough common ground to allow more formal trade talks to move ahead while delaying any further tariff implementation. The problem is that the latest comments from Trump have indicated he is going to be raising the tariff rate to 25% come January, as well as seek to implement tariffs on the rest of Chinese imports to the US. It seems that the President believes the Chinese are feeling greater pressure as their economy continues to slow, and they will be forced to concede to US demands sooner rather than later. And there is no question the Chinese economy is slowing, but it is not clear to me that Xi will risk losing face in order to prevent any further economic disorder. I think it is extremely difficult to handicap this particular meeting and the potential outcomes given the personalities involved. However, I expect that sometime in the next year this trade dispute will be resolved, as Trump will want to show that his tactics resulted in a better deal for the US as part of his reelection campaign.

And those are the big stories today. There are two data points this morning, Case-Shiller House Prices (exp 5.3%) and Consumer Confidence (135.9), but neither seems likely to have an impact on the FX market. However, as mentioned above, Fed vice-chairman Richard Clarida speaks first thing this morning, and his tone will be watched carefully for clues about how the Fed will behave going forward. My take here is that we are likely to hear a much more moderate viewpoint from the Fed given the recent data flow, and that is likely to keep modest pressure on the dollar.

Good luck