Digging In Heels

In Europe they’re digging in heels
Ignoring all UK appeals.
So, Brexit is looming
With Boris assuming
They’ll blink, ratifying his deal

Brexit and the Trade Wars sounds more like a punk rock band than a description of the key features in today’s markets, but once again, it is those two stories that are driving sentiment.

Regarding the former, the news today is less positive that a deal will be agreed. A wide group of EU leaders have said Boris’s latest offering is unacceptable and that they are not willing to budge off their principles (who knew they had principles?). It appears the biggest sticking point is that the proposal allows Northern Ireland to be the final arbiter of approval over the workings of the deal, voting every four years to determine if they want to remain aligned with the EU’s rules on manufactured goods, livestock and agricultural products. This, of course, would take control of the process out of the EU’s hands, something which they are unwilling to countenance.

French President Emmanuel Macron has indicated that if they cannot agree the framework for a deal by this Friday, October 11, there would be no chance to get a vote on a deal at the EU Summit to be held next week on October 17. It appears, at this point, that the EU is betting the Benn Act, the legislation recently passed requiring the PM to ask for an extension, will be enforced and that the UK will hold a general election later this year in an attempt to establish a majority opinion there. The risk, of course, is that the majority is to complete Brexit regardless and then the EU will find itself in a worse position. All of this presupposes that Boris actually does ask for the extension which would be a remarkable climb-down from his rhetoric since being elected.

Given all the weekend machinations, and the much more negative tone about the outcome, it is remarkable that the pound is little changed on the day. While it did open the London session down about 0.35%, it has since recouped those losses. As always, the pound remains a binary situation, with a hard Brexit likely to result in a sharp decline, something on the order of 10%, while a deal will result in a similar rally. However, in the event there is another extension, I expect the market will read that as a prelude to a deal and the pound should trade higher, just not that much, maybe 2%-3%.

Otherwise, the big story is the trade war and how the Chinese are narrowing the scope of the negotiations when vice-premier Liu He arrives on Thursday. They have made it quite clear that there will be no discussion on Chinese industrial policy or subsidies, key US objectives, and that all the talks will be about Chinese purchases of US agricultural and energy products as well as attempts to remove tariffs. It appears the Chinese believe that the impeachment inquiry that President Trump is facing will force him to back down on his demands. While anything is possible, especially in politics, based on all his actions to date, I don’t think that the President will change his tune on trade because of a domestic political tempest that he is bashing on a regular basis. The market seems to agree with that view as well, at least based on today’s price action which can best be described as modestly risk-off. Treasury and Bund yields are lower, albeit only between 1-2bps, the yen (+0.1%) and Swiss franc (+0.2%) have strengthened alongside the dollar and US equity futures are pointing to a decline of 0.2% to start the session. Ultimately, this story will remain a market driver based on headlines, but it would be surprising if we hear very much before the meetings begin on Thursday.

Looking ahead to the rest of the week, the FOMC Minutes will dominate conversation, but we also see CPI data:

Today Consumer Credit $15.0B
Tuesday NFIB Small Biz Optimism 102.0
  PPI 0.1% (1.8% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Wednesday JOLTS Job Openings 7.25M
  FOMC Minutes  
Thursday Initial Claims 220K
  CPI 0.1% (1.8% Y/Y)
  -ex food & energy 0.2% (2.4% Y/Y)
Friday Michigan Sentiment 92.0

Source: Bloomberg

Over the weekend we heard from both Esther George and Eric Rosengren, the two FOMC members who dissented against the rate cuts. Both said they see no reason to cut rates again right now, but if the data do deteriorate, they have an open mind about it. Meanwhile, Friday Chairman Powell gave no hints that last week’s much weaker than expected data has changed his views either. This week brings seven more Fed speakers spread over ten different events, including Chairman Powell tomorrow.

At the same time, this morning saw German Factory Orders decline a more than expected 0.6%, which makes the twelfth consecutive Y/Y decline in that series. It is unambiguous that Germany is in a recession and the question is simply how long before the rest of Europe follows, and perhaps more importantly, will any country actually consider fiscal stimulus? As it stands right now, Germany remains steadfast in their belief it is unnecessary. Maybe a hard Brexit will change that tune!

The big picture remains intact, with the dollar being the beneficiary as the currency of the nation whose prospects outshine all others in the short run. As it appears highly unlikely a trade deal will materialize this week, I see no reason for the dollar to turn around. Perhaps the only place that is not true is if there is, in fact, a break though in the UK.

Good luck
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One thought on “Digging In Heels

  1. Well written. Thanks for trying to summarize (especially Brexit ) what most of the world cannot get a grip on. Extension seems most likely at least that’s how the derivatives market is starting to price in (cautiously ) as this event if you can call it a single event has been repriced at least a dozen times since mid last year!

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