In Brussels they finally agreed
On how Brexit now will proceed
The DUP still
Insist that they will
Vote No, so can Boris succeed?
Methinks that the answer is yes
As many MP’s acquiesce
Their voters are tired
And Boris admired
For finding the key to success
Well, it’s done! Or at least almost done. The UK and the EU have agreed the legal text for the Brexit deal as well as the political declaration for their relationship going forward. It seems that despite all of Parliament’s efforts to undermine the prime minister’s negotiating tactics, the EU realized that a continuation of this process was detrimental to their own well-being. And so a deal has been reached with EU President Jean-Claude Juncker encouraging the other 27 members to ratify the document.
Of course, the UK Parliament still needs to do the same, and the last word was that Arlene Foster and her DUP were not yet willing to accept the terms. The surface calculation is that Boris needs them since he doesn’t have an outright majority in Parliament. However, I think that he will be able to find votes throughout the rest of Parliament. Remember, about half of Labour’s constituents voted to leave as well, so there will be a lot of pressure for Labour MP’s to break ranks and finish this process on Saturday. After that, a vote of no-confidence could bring down Boris’s government, but he will relish the new election. In fact, it is entirely possible that Labour will not seek that vote as a newly emboldened Johnson could easily regain a solid majority and send Jeremy Corbyn to the backbenches forever. At least now, Johnson is somewhat weakened by his coalition.
So what does this mean for markets going forward? It should be no surprise that risk appetite has quickly increased this morning with equity markets popping higher on the news, Treasury yields rising and the dollar falling. Right after the announcement, the pound jumped more than 1.3%, to 1.2990, but it has since given back some of those gains on a combination of profit taking and questions as to whether Parliament will ratify the deal. Still, as I type, the pound is higher by 0.4% since yesterday’s close.
Perhaps of more interest is the rally in the euro, which is also higher by 0.4% this morning. It also spiked on the news, albeit not quite as far, and has been rallying in lockstep with, although not quite at the same trajectory as, the pound for the past two weeks. Since the beginning of October, when negotiations really intensified, the euro is higher by 2.4% while the pound has rallied nearly 6.0%. This ratio seems reasonable to me, and when (if) Parliament ratifies the deal on Saturday, I expect it to continue for a while longer.
But risk appetite means that other currencies are also performing well with AUD today’s top performer after the Unemployment Rate fell surprisingly to 5.2% last night. While the RBA had expressed concern over its recent trajectory, it is up from 4.9% in February, if things are stabilizing Down Under, there is less call for further monetary ease, and so the Aussie responded accordingly. This helped drag kiwi higher (+0.6%), and we are seeing solid strength across the entire G10 front. EMG markets are responding in a similar manner, with the bulk of the space higher by between 0.3% and 0.6%. This includes a cross section of APAC, EEMEA and LATAM currencies, thus implying this is much more about the dollar than any particular currency story.
So what is happening to the dollar? Certainly yesterday’s Retail Sales data (-0.3%; -0.1% ex autos) did not help the greenback, as it showed the first potential cracks in the consumer portion of the economy. This has been the economic (and stock market) bears’ key concern; that a slowdown in the manufacturing sector, which has been evident, would bleed over to the consumer sector. The bulls, and the Fed, continue to point to the strength in the labor market as their rationale to dismiss the idea, but we all know that the Unemployment Rate is a severely lagging indicator, and that it will not start to suffer until other data have already pointed to a sharper slowdown. This morning’s Housing Starts (exp 1320K) and Building Permits (1350K) data will be closely scrutinized in the wake of the Retail Sales numbers, but remember, this is the sector most directly benefitting from the Fed’s recent largesse.
To go back to the question of what is happening to the dollar, I would suggest that the market had been pretty convinced that US growth would continue to exceed that elsewhere in the world, and that despite the Fed’s ‘mid-cycle adjustment’ that interest rates here would remain higher than elsewhere. But if there is now some concern over the US economy slowing more rapidly than previously thought, and that the Fed will need to be more aggressive, the dollar will very likely suffer in the near term. A key question in this scenario is; will market participants continue to add to their risk profiles if the US is sliding into a recession? At some point, one would expect, adding risk will seem the wrong decision, and a risk-off dollar rally is likely to ensue. But we are not yet at that point.
On top of the Housing data we also see Initial Claims (exp 215K); Philly Fed (7.6); IP (-0.2%); and Capacity Utilization (77.7%). Given the recent slowdown in the ISM data, this other data will be carefully watched as well. If it underperforms, look for the probability of a Fed cut in two weeks, currently 82%, to rise further, and the dollar to suffer as well. In addition to the data, we hear from three more Fed speakers, the dovish Charles Evans, and both Michelle Bowman and John Williams, who are much more middle of the road. This has been a very active week for Fed speakers and yet nothing new has come from any of them. The message continues to be that the revived purchases of Treasuries, at a rate of $60 billion per month, is definitely not QE, but merely a technical adjustment to the balance sheet. And beyond that, they are closely watching the data but feel the economy is in a “good place.” I know that makes me feel better!
For the rest of the session, I see no reason for the dollar to reverse course barring something outside this discussion, notably trade talk, popping up. Mercifully, there has been no trade conversation so equity markets are focused on earnings and FX markets are focused on the probability of the Brexit deal being ratified by Parliament. Success on Saturday should open the way for the pound to rally another 3-5 cents next week, especially if the dollar remains under pressure overall.