Each day from the UK we learn
The data implies a downturn
Infections keep rising
Yet what’s so surprising
Is Sterling, no trader will spurn
Investors, it seems, all believe
That fishing rights, Macron’s pet peeve
Will soon be agreed
And both sides proceed
Towards Brexit come this New Year’s Eve
Since the last day of September, the pound has been a top performer in the G10 space, rallying 2.0% despite the fact that, literally, every piece of economic data has fallen short of expectations. Whether it was GDP, PMI, IP or Employment, the entire slate has been disappointing. At the same time, stories about Brexit negotiations continue to focus on the vast gap between both sides on fishing rights for the French fleet as well as state aid limits for UK companies. And yet the pound continues to grind higher, trading back to its highest levels in a month. Granted this morning it has ceded a marginal -0.2%, but that is nothing compared to this steady climb higher.
It seems apparent that traders are not focusing on the macro data right now, but instead are looking toward a successful conclusion of the Brexit negotiations. Granted, Europe’s history in negotiations is to have both (or all) sides agree at the eleventh hour or later, but agree, nonetheless. So, perhaps the investor community is correct, there will be no hard Brexit and thus the UK economy will not suffer even more egregiously than it has due to Covid. But even if a deal is agreed, does it make sense that the pound remains at these levels?
At this stage, the economic prospects for the UK seem pretty awful. This morning’s employment report showed the 3M/3M Employment change (a key measure in the UK) falling 153K. While that is not the worst reading ever, which actually came during the financial crisis in June 2009, it is one of the five worst in history and was substantially worse than market expectations. Of greater concern was that the pace of job cuts rose to the most on record, with 114K redundancies reported in the June-August period. Adding it all up leaves a pretty poor outlook for the UK economy, especially as further lockdowns are contemplated and enacted to slow the resurgence in Covid infections seen throughout various parts of the country. And yet the pound continues to perform well.
Perhaps the rally is based on monetary policy expectations. Alas, the last we heard from the Old Lady was that they were discussing how banks would handle negative interest rates, something which last year Governor Carney explained didn’t make any sense, but now, under new leadership, seems to have gained more adherents. If history is any guide, the fact that the BOE is talking to banks about NIRP is a VERY strong signal that NIRP is coming to the UK in the next few months. Again, it strikes me that this is not a positive for the currency.
In sum, all the information I see points to the pound having more downside than upside, and yet upside is what we have seen for the past several weeks. As a hedger, I would be cautious regarding expectations that the pound has much further to rally.
Turning to the rest of the market, trading has been somewhat mixed, with no clear direction on risk assets seen. Equity markets in Asia saw gains in the Hang Seng (+2.2%) although the Nikkei (+0.2%) and Shanghai (0.0%) were far less enthusiastic. Interestingly, the HKMA was forced to intervene in the FX market last night, selling HKD6.27 billion to defend the strong side of the peg. Clearly, funds are flowing in that direction, arguably directly into the stock market there, which after plummeting 27.5% from January to March on the back of Covid concerns, has only recouped about 42% of those losses, and so potentially offers opportunity. Perhaps more interestingly, last night China reported some very solid trade data, with imports rising far more than expected (+13.2% Y/Y) and the Trade Balance falling to ‘just’ $37.0B. Export growth was a bit softer than expected, but it seems clear the Chinese economy is moving forward.
European bourses, however, are all in the red with the DAX (-0.4%) and CAC (-0.3%) representative of the general tone of the market. Aside from the weak UK employment data, we also saw a much weaker than expected German ZEW reading (56.1 vs. 72.0 expected), indicating that concerns are growing regarding the near-term future of the German economy.
In keeping with the mixed tone to today’s markets, Treasuries have rallied with yields falling 2 basis points after yesterday’s holiday. Perhaps that is merely catching up to yesterday’s European government bond markets, as this morning, there is no rhyme or reason to movement in this segment. In fact, the only movement of note here is Greece, which has seen 10-year yields decline by 3bps and which are now sitting almost exactly atop 10-year Treasuries.
As to the dollar, mixed is a good description here as well. In the G10 space, given the German data, it is no surprise that the euro has edged lower by 0.2% nor that the pound has crept lower as well. AUD (-0.24%) is actually the worst performer, which looks a response to softness in the commodity space. SEK (+0.3%) is the best performer after CPI data turned positive across the board, albeit not rising as much as had been forecast. You may recall the Swedes are the only country that had moved to NIRP and then raised rates back to 0.0%, declaring negative rates to be a bad thing. The previous few CPI readings, which were negative, had several analysts calling for Swedish rates to head back below zero, but this seems to support the Riksbank’s view that no further rate cuts are needed.
Emerging market currencies are under a bit more pressure, with the CE4 leading the way lower (CZK -0.8%, PLN -0.7%, HUF -0.65%) but the rest of the bloc has seen far less movement, generally +/- 0.2%. Regarding Eastern Europe, it seems there are growing concerns over a second wave of Covid wreaking further havoc on those nations inspiring more rate cuts by the respective central banks. Yesterday’s Czech CPI data, showing inflation falling into negative territory was merely a reminder of the potential for lower rates.
Speaking of CPI, that is this morning’s lead data point, with expectations for a 0.2% M/M gain both headline and ex food and energy, which leads to 1.4% headline and 1.7% core on a Y/Y basis. Remember, these numbers have been running higher than expectations all summer, and while the Fed maintains that inflation is MIA, we all know better. I see no reason for this streak of higher than expected prints to be broken. In addition, we hear from two Fed speakers, Barkin and Daly, but we already know what they are likely going to say; we are supporting the economy, but Congress needs to enact a fiscal support package, or the world will end (and it won’t be their fault.)
US equity futures are a perfect metaphor for the day, with DOW futures down 0.4% and NASDAQ futures higher by 0.9%. In other words, it is a mixed picture with no clear direction. My fear is the dollar starts to gain more traction, but my sense is that is not in the cards for today.
Good luck and stay safe