The Ides of October are near
The date by which Boris was clear
If no deal’s agreed
Then he will proceed
To (Br)exit with nary a tear
We are but one week away from the date widely touted by UK PM Johnson as the deadline to reach a deal with the EU on the terms of the post-Brexit relationship between the two. It seems the date was set with several issues in mind. First, there is an EU summit to be held that day and the next, and the idea was that any agreed upon deal could be reviewed at the summit and then there would be sufficient time for each of the remaining 27 EU members to enact legislation that would enshrine the deal in their own canon of laws.
On the other hand, if no deal is reached by then, the Johnson government would have the ensuing two- and one-half months to finalize their Brexit plans including such things as tariff schedules and customs procedures. At the same time, while Boris has been adamant that October 15 is the deadline, the EU has been clear that they see no such artificial deadline and are perfectly willing to continue the negotiations right up until December 31. The idea here is that if an agreement comes that late, a temporary measure can be put in place while each member enacts the appropriate legislation.
Back on September 29, in All Doom and Gloom, I posited that the market was pricing in a two-thirds probability of a hard Brexit. The analysis was based on the level of the pound relative to its longer-term valuations and historical price action. But clearly there is far more to the discussion in these uncertain times than simply historical price action. And in the ensuing days I have reconsidered my views of both the probability of a hard Brexit and my estimation of the market’s anticipation.
For what it’s worth, I have come to the belief that a hard Brexit remains an unlikely event, less than a 20% probability. Intransigence in international negotiations is the norm, not an exception, so all of Boris’s huffing and puffing is likely just that, hot air. And in the end, it is not in either side’s interest to have the UK leave with no deal in place. Too, the ongoing pandemic has distracted most people from the potential impacts of a hard Brexit, and my understanding is that the subject is hardly even newsworthy on the Continent. The point is, on the EU side, other than the French fishermen, Brexit is not something of concern to the population. After all, they are far more concerned with whether or not they will remain employed, be able to feed their families and pay rent, and who will win the UEFA Cup. For most of Europe, the UK is an abstract thought, although not for all of it. (An interesting statistic is that German exports to the UK have already fallen 40% since immediately after the Brexit vote four years ago.) As such, if the EU were to soften their stance on some of the last issues, virtually nobody would notice, certainly not their constituents so, there is likely little price for EU politicians to pay electorally, with that outcome.
The UK, on the other hand, remains highly focused on Brexit, and Boris would certainly suffer in the event that any eventual deal is not widely perceived as beneficial to the UK. The UK, of course has other problems, notably that the virus is spreading more widely again, and the government response has been to reimpose restrictions and lockdowns in the hardest hit areas. Of course, this is exactly the thing to halt a recovery in its tracks, which if added to the potential harm from a no-deal Brexit, may be too much for Boris to withstand. But it is the other problems which are a key driver of the pound’s exchange rate, and the main reason I don’t expect any significant rally from current levels. Instead, I believe the odds are for a retreat to the 1.20-1.25 level, regardless of the Brexit outcome. A signed deal would merely delay the achievement of that target for a few months, at best. The combination of growing fiscal deficits, additional BOE policy ease and a sluggish economic recovery all point to the pound weakening over time. While a hard Brexit will accelerate that outcome, even a deal will not prevent it from occurring. Hedgers beware.
On to markets. Yesterday’s US equity rally begat the same in Asia (Nikkei +1.0%, Australia +1.1%) and Europe, after a slow start, has turned higher as well (DAX +0.7%, CAC +0.55%). China’s weeklong holiday is ending today, and their markets will reopen tonight. US futures are also pointing higher, roughly 0.5% across the board. It seems that the market remains entirely beholden to the US stimulus talks, and yesterday, after the President said negotiations would cease until after the election, that tune changed as there was talk of stand-alone bills on airline support or a second round of $1200 checks for previous recipients. I have to admit that the market response to the stimulus talks reminds me of the response to the trade talks with China at the beginning of last year, with each positive headline worth another 0.5% in gains despite no net movement.
Bond markets are in vogue this morning as yields are lower in Treasuries and throughout Europe. Of course, 10-year Treasury yields have been trending higher for the past week and a half and are now more than 25 basis points higher than their nadir seen on August 4th. Yesterday’s 10-year auction went off without a hitch, with the yield right on expectations and solid investor demand. Meanwhile, yesterday’s FOMC Minutes explained that several members would consider even more bond buying going forward, which cannot be a surprise given what we have heard from the most dovish members since then. Just this week, Minneapolis Fed President Kashkari
said just that. But with that in mind, remember that despite the prospect of more bond buying, Treasury yields are at the high end of their recent range and look like they have further to climb. Again, this appears to be a market commentary on inflation expectations, and one that I presume the Fed is encouraging!
As to the dollar, it is very slightly softer at this point of the session, although not universally so. Looking at the G10 space, the biggest mover is AUD, with a gain of just 0.25%. Meanwhile, both EUR and CHF have edged lower by 0.1%. The point is there is very little activity or movement as there have been few stories or data of note overnight. EMG currencies have shown a bit more strength led by RUB (+0.7%) and MXN (+0.6%), both benefitting from oil’s modest gains this morning. The rest of the bloc has seen much less positivity, with only KRW (+0.4%) on the back of a widening trade surplus and HUF (+0.3%) after CPI data today showed a modest decline, thus allowing the central bank to maintain its current policy settings.
On the US calendar we get Initial Claims (exp 820K) and Continuing Claims (11.4M), still the timeliest economic information we receive. The issue here is that after the initial post-Covid spike, the decline in these numbers has really slowed down. In other words, there are still many layoffs happening, hardly the sign of a robust economy. In addition, we hear from three more Fed speakers, but their message is already clear. ZIRP for years to come, and they will buy bonds the whole time.
Investors remain comfortable adding risk these days, as the central banking community worldwide continues to be seen as willing to provide virtually unlimited support. If risk continues to be “on”, I see little reason for the dollar to rally in the short term. But neither do I see much reason for it to decline at this stage.
Good luck and stay safe