Ill at Ease

The nation that once ruled the seas
Has lately been brought to its knees
The Minister, Prime
Has run out of time
And Parliament’s still ill at ease

In ten days, some votes will be held
As MP’s there all feel compelled
To take more control
Around the black hole
Of Brexit, so fears might be quelled

There continue to be two main stories driving markets, Brexit and the trade war between the US and China. Everything else has faded into the background amid moderating global growth and concerns of worse to come.

Starting with Brexit, in a week and a half (it’s actually 11 days, but that didn’t fit into the limerick), Parliament will be holding a series of votes to try to wrest control of the process from the government and to explain their demands on behalf of the ‘people’. Alas, what is clear is that there is no consensus on how to proceed, with a large number not wanting to go through with it at all, while others seek a hard Brexit. PM May has insisted that the vote was for leaving the EU, and that is exactly what the UK is going to do. Currently, the best idea that anybody seems to have is to seek to delay the official date for up to a year in order to come up with more support for any action at all. There is talk of holding a second referendum, talk of a snap election to help PM May win a mandate on how to proceed, and talk of a hard Brexit. The one thing that is clear is that the deal on the table will not be the roadmap, at least not as currently written.

With all that in mind, the FX market is starting to vote, and they are coming around to the idea that there will be no Brexit at all. At least that is my take on the fact that the pound has been rising steadily since the beginning of the year. While it is actually slightly softer this morning (-0.35%) on the back of weaker than expected Retail Sales figures (-0.9% in Dec), it is higher by 3.5% since January 2nd. My view that a hard Brexit will result in a much lower pound is universal, while a deal would clearly help the pound’s value. But no Brexit at all might open up a very significant rally. Remember, before the vote, the pound was trading around 1.45-1.50. Price action indicates to me that there are more and more traders and speculators who are betting on no Brexit and a sharp rebound. I will say that if there is a decision to hold a second referendum, look for the pound to rally very sharply, easily another 5%-8%, and to do so quickly. I just don’t think there will be another referendum.

As to the trade spat, the WSJ published an article of rumors and innuendo about the idea that the US is contemplating removing tariffs as a sign of good faith and a spur to help an agreement be reached. What was interesting was that at the very end of the article, it was mentioned that all of this talk was in the context of how to move the talks forward, and not an agreed plan of action. But equity markets around the world continue to look for positive catalysts and the end of the trade war would definitely fit that bill. Given the story was published late yesterday afternoon, it is no surprise that equity markets around the world have rallied, with Asia (Nikkei +1.3%, Shanghai +1.4%) and Europe (+1.0%-1.5% across the board) both performing quite well while US futures are pointing higher as well, albeit not quite as robustly (+0.4%). But the dollar has seen very little impact from this news as aside from the pound’s modest decline, it is doing very little overall.

Beyond those stories, much less of note is happening. Next week the ECB meets, and we are starting to see analysts discuss the prospects for the previously expected rate hikes later this year. Given the ongoing softness in Eurozone data, it remains hard to believe that the ECB is going to think that raising rates is the correct move. Rather, more likely will be an extension of the TLTRO’s and interest rates remaining right where they are for an extended period from here. All eyes will be on Signor Draghi’s characterization of the economy, as to whether risks are tilted to the downside or things are balanced, but even if he claims balance, the reality is the data is pointing lower. At some point, that will be acknowledged, and it will be clearer to all that policy will not tighten further in Europe for many years. In fact, it is much easier to believe that the next move will be for easier policy than tighter. And as I have continued to explain, I believe that will help the dollar overall.

As to this morning’s data, we see IP (exp 0.2%), Capacity Utilization (78.5%) and Michigan Sentiment (97.0). Canadian Inflation is also on the docket (1.7%), which hardly seems a reason to expect higher rates there. Looking ahead, there are no more Fed speakers until the meeting on the 30th as they have entered their quiet period. But the message we have received is quite clear, patience is a virtue and there will be no rate hike in either January or March. After that, if the data supports the idea that growth and inflation are picking up, I think they will move, but unfortunately, given the overall tone of data, that seems unlikely. As to the tone for today, it is hard to get too excited about the FX market without further specific news. It wouldn’t surprise to see the pound drift a bit lower as there will be some profit taking on the recent move, but for now, the dollar is likely to remain under very modest pressure overall. Especially if equities in the US perform like those elsewhere.

Good luck and good weekend