In Hong Kong, the protestors won
In England, the fun’s just begun
But as of today
Bremain’s holding sway
And risk has begun a new run

As New York walks in this morning, there have been significant changes in several of the stories driving recent price action with the upshot being that risk is clearly in favor today. Things started in Hong Kong, where Carrie Lam, the territory’s Chief Executive, formally withdrew the extradition bill that had prompted three months of increasingly violent protests there. The quick back story is that this bill was presented in June as a response to a situation where a man accused of murder in Taiwan could not be returned there for trial due to the lack of formal extradition mechanisms in the existing legal framework. However, the bill they crafted was quite open-ended and would have allowed for extradition to the mainland for minor infractions, a situation seen as fraught with danger for Hong Kong’s shrinking independence. That is what begat the protests, and although they have grown in scope as well as size, it is seen as a significant first step to restoring order. It is hard to believe that Beijing is happy with this outcome as they were strong supporters of the bill, but thus far, they have made no comment.

As it happens, financial markets saw this as a significant change in the tone for the future and there was a massive equity rally in HK, while risk assets generally performed well at the expense of haven assets. So the Hang Seng rose nearly 4.0% with other APAC stock markets also gaining, albeit not to the same extent. European markets are also on the move this morning, with gains ranging from the FTSE 100’s +0.4% to the FTSE MIB (Italy) up 1.65%. And don’t worry, US equity futures are all pointing higher as well, on the order of 0.75%. Meanwhile, Treasuries have sold off modestly, with the 10-year yield higher by 3bps, Bunds have fallen further, with yields there up by 6bps, and the yen has bucked the trend in currencies, falling 0.25% amid a broad dollar decline. Finally, gold is lower by 0.65%, although remains near the top of its recent trading activity.

The other story that has seen significant changes comes from London, where PM Boris Johnson has not only lost a vote regarding his ability to deliver Brexit, but also has lost his slim majority in parliament after a single member defected to the LibDems. Subsequent to that, there was a vote on a bill brought to the floor to prevent the PM from forcing a no-deal Brexit, one which Boris opposed but passed 328-301 with 21 Tories voting against the PM. Johnson summarily fired those rebels from the party and now leads a minority government. His current tactic is to push for a snap election on October 14 or 15 so that a new government will be available to speak to the EU at a formal meeting on October 18. However, he needs two-thirds of all members of parliament to vote for that, meaning he needs the Labour party to agree. If you are confused by this back and forth, don’t feel too badly, I think pretty much everyone is, and there is certainly no clarity as to what will come next.

With that convoluted process in mind, from a markets perspective the result is clear, the probability of a no-deal Brexit has receded for the moment and the pound has been the biggest beneficiary, rallying 0.9% this morning and is now more than two cents above yesterday’s depths. While this move certainly makes sense given the current understanding of the situation, it is by no means the end of the story. If anything, it is the end of chapter one. Later today we should know if there is going to be another election and then it will take a little time before the market understands the odds of those outcomes. Remember, if there is an election and Jeremy Corbyn is seen with a chance to win, it will not be a positive for the pound or the UK economy either. For now, the market is focused on a somewhat lower probability of a hard Brexit and the pound is benefitting accordingly. However, I don’t think the binary nature of the problem has disappeared, simply been masked temporarily. For hedgers, implied volatility has fallen sharply on the back of this news and the ensuing move, but I would argue uncertainty remains quite high. Options still make a lot of sense here.

Past those two stories, there is no further news on the trade front, although that will certainly become the topic du jour again soon. In the meantime, recent data has continued to paint a mixed picture at best for the G10 economies. For example, yesterday’s ISM data printed at 49.1, well below expectations and the worst print since January 2016. While one print below 50.0 does not indicate a recession is upon us, it is certainly a harbinger of slower growth in the future. Then this morning we saw Service PMI’s from Europe with Italy’s much weaker than expected while France, Germany and the Eurozone as a whole printed at expectations. However, expectations still point to slowing growth, especially in combination with the manufacturing surveys which are mostly sub 50.0. In the UK, the PMI was also weak, 50.6, and there is talk that Q3 is going to result in modest negative GDP performance causing a technical recession in the UK joining Germany and Italy in that regard. In the end, while the trade war may be negatively impacting both the US and China, it is also clearly having a big impact throughout Europe and the rest of the world.

As to the rest of the FX market, the risk on behavior has led to broad based dollar weakness, with the euro rebounding 0.35%, Aussie and Kiwi up similar amounts and the Skandies rallying even further, +0.7%. Canada is a bit of an outlier here as oil prices have been under pressure lately, although have bounced 1.0% this morning, but more importantly, the BOC meets with great uncertainty as to whether they will cut rates or not. Markets are pricing in a 92% chance they will do so, but the analyst community is split about 50/50 on the prospects for a cut today. That said, those same analysts are looking for cuts later this year, so this seems more about timing than the ultimate result.

In the EMG bloc ZAR has had another winning day, rising 1.4% as international bond buyers continue to aggressively buy South African paper after the country averted a recession. But broadly, the dollar is lower against virtually all EMG currencies due to risk-on sentiment.

On the data front, this morning brings the Trade Balance (exp -$53.4B) a modest decline from last month’s outcome, and then the Beige Book comes at 2:00 but that’s all. We will hear from a plethora of Fed speakers today, five in all, ranging from uber doves Kashkari and Bullard to moderate Robert Kaplan from Dallas. Yesterday, Bullard in another speech said the Fed should cut 50bps at the upcoming meeting while Boston’s Rosengren said there didn’t seem to be the need to do anything right now. A full cut plus some is still priced in at this point.

In the end, broad risk sentiment is today’s driver. As long as that remains positive, look for the dollar to remain under pressure.

Good luck
Adf