From Brussels, a letter was sent
To London, with which the intent
Was telling the British
The EU’s not skittish
So, don’t try, rules, to circumvent

The pound is under pressure this morning, -0.6%, after it was revealed that the EU is inaugurating legal proceedings against the UK for beaching international law.  The details revolve around how the draft Internal Market Bill, that has recently passed through the House of Commons, is inconsistent with the Brexit agreement signed last year.  The specific issue has to do with the status of Northern Ireland and whether it will be beholden to EU law or UK law, the latter requiring a border be erected between Ireland, still an EU member, and its only land neighbor, Northern Ireland, part of the UK.  Apparently, despite the breathless headlines, the EU sends these letters to member countries on a regular basis when they believe an EU law has been breached.  As well, it apparently takes a very long time before anything comes of these letters, and so the UK seems relatively nonplussed over the issue.  In fact, given that the House of Lords, which is not in Tory control, is expected to savage the bill, it remains quite unclear as to whether or not this will be anything more than a blip on the Brexit trajectory.

However, what it did highlight was that market participants have grown increasingly certain that an agreement will be reached, hence the pound’s recent solid performance, and that this new wrinkle was enough for weak hands to be scared from their positions.  At this point, almost everything that both sides are doing publicly is simply intended to achieve negotiating leverage as time runs out on reaching a deal.  Alas for Boris, I feel that his biggest enemy is Covid, not Brussels, as the EU is far more concerned over the pandemic impact and how to respond there.  At the margin, while a hard Brexit is not preferred, the fear of the fallout in Brussels has clearly diminished, and so the opportunity for a hard Brexit to be realized has risen commensurately.  And the pound will fall further if that is the outcome.  The current thinking is there are two weeks left for a deal to be reached so expect more headlines in the interim.

The Tankan painted
A picture in black and white
Spring remains distant

Meanwhile, it is still quite cloudy in the land of the rising sun, at least as described by the Tankan surveys.  While every measure of the surveys, both small and large manufacturing and non-manufacturing indices, improved from last quarter by a bit, every one of them fell short of expectations.  The implication is that PM Suga has his work cut out for him in his efforts to get economic activity back up and running.  You may recall that CPI data on Monday showed deflation remains the norm, and weak sentiment is not going to help the situation there.  At the same time, capital flows continue to show significant foreign outflows in both stock and bond markets there.  It was only two weeks ago that the JPY (-0.1% today) appeared set to break through the 104 level with the dollar set to test longer term low levels.  Of course, at that time, the market narrative was all about the dollar falling sharply.  Well, both of those narratives have evolved, and if capital continues to flow out of Japan, it is hard to make the case for yen strength.  Remember, the BOJ is never going to be seen as relatively tighter in its policy stance, so a firmer yen would require other drivers.  Right now, they are not in evidence.

And frankly, those are the two most interesting stories in the market today.  Arguably, the one other theme that has gained traction is the rise in layoffs by large corporations in the US.  Yesterday nearly 40,000 were announced, which is at odds with the idea that the economy here is going to rebound sharply.  On an individual basis, it is easy to understand why any given company is reducing its workforce in the current economic situation.  Unfortunately, the picture it paints for the immediate future of the economy writ large is one of significant short-term pain.  Given this situation, it is also easy to understand why so many are desperate for Congress to agree a new stimulus bill in order to support the economy.  And it’s not just elected officials who are desperate, it is also the entire bullish equity thesis.  Because, if the economy turns sharply lower, at some point, regardless of Fed actions, equity markets will reprice lower as well.

But that is not happening today.  As a matter of fact, equities are looking pretty decent, yet again.  China is closed for a series of holidays, but the overnight session saw strength in Australia (+1.0%) although the Nikkei (0.0%) couldn’t shake off the Tankan blues.  Europe, however, is all green led by the FTSE 100 (+0.9% despite that letter) with the CAC (+0.65%) and DAX (+0.1%) also positive.  US futures are all pointing higher with gains ranging from 0.8%-1.25%.

Bond markets actually moved yesterday, at least a little bit, with 10-year Treasury yields now at 0.70%.  Yesterday saw a 3.5 basis point move with the balance occurring overnight.  Given yesterday’s equity rally, this should not be that surprising, but given the recent remarkable lack of movement in the bond market, it still seems a bit odd.  European bond markets are behaving in a full risk on manner as well, with havens like Bunds, OATS and Gilts all seeing yields edge higher by about 1bp, while Italy and Greece are seeing increased demand with modestly lower yields.

As to the dollar overall, despite the pound’s (and yen’s) weakness, it is the dollar that is under pressure today against both G10 and EMG currencies.  Today’s leader in the G10 clubhouse is NOK (+0.55%) which is a bit odd given oil’s 1.0% decline during the session.  But after that, the movement has been far less enthusiastic, between 0.1% and 0.3%, which feels more like dollar softness than currency strength.

EMG currencies, however, are showing some real oomph this morning with the CE4 well represented (HUF +1.15%, PLN +0.85%) as well as MXN (+1.05%) and INR (+0.85%).  The HUF story revolves around the central bank leaving its policy rate on hold after a surprise 0.15% rise last week.  This was taken as a bullish sign by investors as the central bank continues to focus on above-target inflation there.  Meanwhile, inflation in Poland rose 3.2% in a surprise, above their target and has encouraged views that the central bank may need to tighten policy further, hence the zloty’s strength today.  The India story revolves around the government not increasing their borrowing needs, despite their response to Covid, which helped drive government bond investor inflows and rupee strength.  Finally, the peso seems the beneficiary of the overall risk-on attitude as well as expectations for an uptick in foreign remittances, which by definition are peso positive.

On the data front, yesterday saw ADP surprise higher by 100K, at 749K.  As well, Chicago PMI, at 62.4, was MUCH stronger than expected.  This morning brings Initial Claims (exp 850K), Continuing Claims (12.2M), Personal Income (-2.5%), Personal Spending (0.8%), Core PCE (1.4%) and ISM Manufacturing (56.4).  US data, despite the layoff story, has clearly been better than expected lately, and this can be seen in the increasingly positive expectations for much of the data.  While European PMI data this morning was right on the button, the numbers remain lower than those seen in the US.  In addition, the second wave is clearly hitting Europe at this time, with Covid cases growing more rapidly there than back in March and April when it first hit.  As much as many people want to hate the dollar and decry its debasement (an argument I understand) it is hard to make the case that currently, the euro is a better place to be.  While the dollar is soft today, I believe we are much closer to the medium-term bottom which means hedgers should be considering how to take advantage of this move.

Good luck and stay safe
Adf