Cause For Concern

Once more to Great Britain we turn
And so we ask, ‘what did we learn?’
May’s Deal lacks appeal
But No-Deal they feel
Is still quite a cause for concern

Where’s Howie Mandel when you need him to say, “Deal…or No Deal?”

In yet another loss for beleaguered British PM May, the House of Commons yesterday approved a bill ruling out a no-deal Brexit for the UK. Of course, the day before they defeated the only Brexit deal on the table. Like a spoiled child, they cannot figure out what they want, but they know they want something. The next step is to request an extension of the deadline, which is now just 15 days away. However, even on that subject there is no clarity. The length of that extension has been open to debate with many different answers. For the pro-Brexit crowd, those willing to see a no-deal outcome, they want as short a delay as possible. Anything beyond six months is likely to allow a second referendum, with the current polls showing that Bremain would be the winner. Naturally, those who want to remain are seeking the longest extension possible.

But it is important to remember that the other 27 members of the EU need to approve the extension unanimously, which when it comes to EU activities is certainly the exception, not the rule. For example, what if Hungary, which is currently at odds with the EU over other issues, decides to vote against an extension simply to tweak the rest of the bloc’s collective nose? My point is that an extension, while pretty likely, is hardly guaranteed. And we have already heard from a number of different EU members on the importance of a rationale for an extension. Ultimately, now that Parliament has taken control of the process from PM May, they have to decide what they want to do, not merely what they want to avoid. And thus far, that information has been lacking.

Turning to the market reaction, the pound rallied sharply yesterday, a full 2.0%, as traders and investors gained confidence that the UK would not be crashing out of the EU without a deal. Of course, given the current lack of alternatives, that remains a fraught situation. This morning, it has ceded about 0.65% of those gains between profit-taking and a dawning realization that just because they voted not to leave without a deal, that hasn’t actually solved the problem. In the end, there is much more to this process and this story, with the potential for both a bigger rally, if somehow the UK comes up with a viable solution, or a much bigger decline, if the delay doesn’t help solve the problem.

The other noteworthy news has been the postponement of a meeting between President’s Xi and Trump to sign any trade deal. While there had been recent indications that progress was being made, apparently it has not been enough progress to schedule a meeting. In the end, as I have written repeatedly, it is difficult for China to agree to not steal IP and force technology transfers when they have maintained, all along, that they don’t do that to begin with. In addition, yesterday President Trump indicated he was in “no hurry” to sign a deal, so this cloud is likely to hang over the global economy for a while yet.

As evidence of that cloud, Chinese data last night pointed to further slowing in the economy there as IP fell to a 5.3% growth rate, the slowest since 2002! While Retail Sales remained unchanged at 8.2%, auto sales continue to decline, falling -2.8% in the January-February period from year ago levels. (The Chinese statistics agency combines Jan and Feb every year to try to smooth the impact of the Chinese New Year, which typically floats in that period.) Interestingly, the combination of these two stories, trade disappointment and weak data, has led to the renminbi slipping 0.5% this morning, a pretty big move for the currency.

Away from those two stories, we continue to see signs of slowing growth around the developed world with rising Swedish Unemployment (6.6% vs. 6.3% previously) and a continued lack of inflationary pressure from both Germany (1.5%) and France (1.3%). This has helped reverse the euro’s recent modest strength with the single currency lower by 0.25% this morning.

In fact, the dollar is having a strong day virtually everywhere, with Aussie and Kiwi both falling more than 0.5% after the weak Chinese data raised concerns over their key export market. Meanwhile, even the yen is lower by 0.45%, as the economic story there continues to point to slowing growth and the possibility of yet more monetary policy ease. The problem for Kuroda-san is there are precious few things left to do. After all, he already has negative interest rates and owns 43% of the JGB market, as well as 10% of the equity market, all while maintaining a cap on the yield of the 10-year JGB. Barring explicit monetization of the debt, meaning relieving the Japanese government of the obligation to repay the debt on their balance sheet, the list is short. However, if they do go to explicit monetization, you can be sure the yen will fall sharply.

Equity markets, however, remain oblivious of all the potential problems that exist and continue to focus on a single thing, easy money. Slowing growth and weaker profitability are meaningless in the new world. The only thing that matters is free cash. My observation on this phenomenon is that it has diminishing returns. And despite ongoing efforts to prop up the economy by central banks everywhere, equity markets, while well off the lows seen in December, have not been able to take the next step higher. To my untrained eye, it appears that the top has been put in, and that lower is the most likely direction over time. But perhaps not today, where equities continue to hang in there and US futures are pointing slightly higher.

Today’s data is just Initial Claims (exp 225K) and New Home Sales (620K), neither of which is likely to have a significant impact. With no Fed speakers, the market is going to be focused on the UK, with their next vote to extend the Brexit deadline, but away from that, has no obvious catalysts. Given the dollar’s decline yesterday, and the rebound thus far today, my money is on a modest continuation of the rebound, at least for the rest of the day.

Good luck