Much Dissension

The market has turned its attention
To Draghi to see if he’ll mention
More buying of bonds
Or if he responds
To those who expect much dissension

While there were fireworks galore yesterday in London, where the UK Parliament had their last meeting before prorogation, this morning sees a much calmer market attitude overall. In brief, Boris did not fare well yesterday as he was unable to achieve his goal of a snap election while Parliament passed a law requiring him to ask for an extension on Brexit if there is no deal at the deadline. (I wonder what will happen if he simply chooses not to do so as that seems entirely feasible given the situation there). The market has absorbed the past several days’ activities with increasing amazement, but ultimately, FX traders have started to price out the probability of a hard Brexit. This is clear from the pound’s nearly 3.0% rally in the past week. While much will certainly take place during the next five weeks of prorogation, notably the party conferences, it would seem the only true surprise can be that a deal has been agreed, at which point the pound will be much higher. I don’t foresee that outcome, but it cannot be ruled out.

With Brexit on the back burner, the market is moving on to the trio of central bank meetings over the next nine days. This Thursday we hear from Signor Draghi while next week brings Chairman Powell on Wednesday and then Governor Carney on Thursday. What makes the ECB meeting so interesting is the amount of pushback that Draghi and his fellow doves have received lately from the northern European hawks. While it is never a surprise that the Germans or Austrians remain monetary hawks, it is much more surprising that Franҫois Villeroy de Galhau, the French ECB member and Governor of the Bank of France, has also been vocal in his rejection of the need for further QE at this time. The issue breaks down to whether the ECB should use its very limited arsenal early in an effort to prevent a broader economic downturn, or whether they should wait until they see the whites of recession’s eyes before acting. The tacit admission from this argument is that there is only a very limited amount of ammunition left for the ECB, despite Draghi’s continuous comments that they have many things they can do if necessary.

Unlike the FOMC or most other central banks, the ECB tries not to actually vote on policy, but rather come to a consensus. However, in this case, it may come to a vote, which would likely be unprecedented in and of itself. It would also highlight just how great the split between views remains, and implies that Madame Lagarde, when she takes the reins on November 1st, will have quite a lot of work ahead if she wants to continue along the dovish path.

In the doves’ favor is this morning’s data releases which showed French IP rebounding less than expected from last month’s disastrous reading (0.3%, -0.2% Y/Y) and Italian IP falling more sharply than expected (-0.7%). Meanwhile, after better than expected GDP data yesterday, the UK employment situation also showed a solid outcome with the Unemployment Rate falling back to 3.8% while earnings rose 4.0%, their highest rate since 2008.

And what did this do for currencies? Well, in that respect neither of these data points had much impact. The euro is lower by a scant 0.1% while the pound is essentially unchanged on the day. In fact, that is a pretty good description of the day overall, with the bulk of the G10 trading +/-0.20% from yesterday’s closing levels although the Skandies have seen more substantial weakness (SEK -0.8%, NOK -0.6%). In both cases, CPI was released at softer than expected levels (SEK 1.4%, 1.6% core; NOK 1.6%, 2.1% core) for August, which puts a crimp in the both central banks’ goal to push interest rates higher by the end of the year.

Turning to emerging markets, the largest movers have been ZAR which gained 0.5% after Factory Output fell a less than expected 1.1% and hope springs eternal for further stimulus driving bond investment. In second place was the renminbi, which has gained 0.25% overnight after the government there, in the guise of SAFE, removed barriers for investment in stocks and bonds. Clearly China has been trying to increase the importance of the renminbi within global financial markets, and allowing freer capital flow is one way to address that concern. However, this process has been ongoing for more than 20 years which begs the question, why now? It is quite reasonable to estimate that the continued pressure being applied by the US via the tariffs and trade war are forcing China to change many things that they would have preferred to keep under their own control. And while it is certainly possible they would have done this anyway, history suggests that the Chinese do not willingly reduce their control over any aspect of the economy. Just a thought. At any rate, initially this freedom is likely to see an inflow of assets as most investors and fund managers are underweight Chinese assets. The newfound ability to move funds in and out is likely to see an inflow to start, with corresponding CNY strength.

Beyond those stories though, it has been pretty dull. Treasury yields are lower by just 1bp, hardly the stuff of a risk assessment, while equity markets are slightly softer after a mixed, but basically flat, day yesterday. At this point, the market is looking toward Signor Draghi, who given futures markets are pricing a 100% chance of a 10bp cut and a 50% chance of a 20bp cut, along with a strong probability of the restarting of QE, has the chance to significantly disappoint. If that is the case, look for the euro to rally quickly, although a move of more than 1.0%-1.5% seems unlikely.

As for today, the NFIB Small Business Optimism Index was released at a bit worse than expected 103.1, perhaps indicating the peak is behind us (certainly my view) and at 10:00 we see the JOLTS Job Opening report (exp 7.331M). But it is really shaping up to be a quiet one with everyone thinking about the ECB until Thursday morning.

Good luck
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