Death Knell

Though dinner was not quite a bust
And everything key was discussed
No deal was secured
And now we’re assured
Past Sunday all hope will combust

The pound, not surprisingly, fell
As traders have heard its death knell
Now eyes have all turned
To Frankfurt, concerned
Christine, Europe’s problems, won’t quell

One need only look at the pound’s performance this morning (GBP -0.8%) to understand that last night’s much touted dinner meeting between Boris and Ursula did not come to any conclusions.  While there appeared to be great comradery all around, and both parties were quick to say they understand how the other side feels, neither was willing to give ground.  The upshot is that the newest deadline appears to be this Sunday coming, when if a deal is not reached, there is a consensus that no deal will be reached in time.  While I continue to believe that this remains political theater, even if Sunday is simply another false deadline, the real deadline is now exactly 3 weeks away, so something needs to happen soon if a no-deal Brexit is to be prevented.  History has shown that deals of this nature, especially in Europe, always come down to the last possible moment.  We shall see if Sunday is that moment.  As to the potential impact on the pound, no-deal could easily take us to 1.25, while a successful conclusion is probably good for 1.40.

On to the day’s other major event, the ECB meeting, where Madame Lagarde is presiding over her fractious team once again as they seek to explain to us exactly what recalibration means.  You may recall that at the October meeting, Lagarde promised that the ECB would “recalibrate” its tools by this meeting.  This has come to be code for increased monetary policy easing of the following nature: €500 billion of additional PEPP purchases and a minimum 6-month extension of both the emergency pandemic program as well as the original QE, the APP (Asset Purchase Program) to run through the end of 2021.  In addition, the TLTRO III program is expected to be extended and expanded.  Expectations are growing that there may be two more tranches of these loans, that the loan tenors may be extended beyond 3 years, and that the interest rate, currently -1.0%, could be cut further.  One of the problems with the TLTRO, though, is that the two biggest users, Italy and Spain, have almost run out of capacity to use more of these loans, so any benefit on this front, even with expansion, is likely limited.

And truthfully, those are really the two key stories of the session so far.  Interestingly, yesterday’s news about an agreement regarding the EU’s pandemic budget seems to have had virtually no impact on the markets as yet.  You may recall that when this was first mooted, back in the summer, and the idea that the EU would issue joint bonds was agreed, many thought this was Europe’s Hamiltonian moment, finally bringing Europe’s fiscal house under one roof, and preparing for great things going forward.  So far, this has not been the case.  But the lack of market response to key steps forward must be a little disheartening for those involved.  Of course, it remains to be seen if this budget is truly the beginning of something new, or simply a response to the Covid pandemic, where Germany and its frugal neighbors felt they had no choice but to accept the outcome.  Certainly, if this is the true way forward, it removes one of the biggest structural impediments to the single currency and opens the way for a secular appreciation.  We shall see.

As to markets today, yesterday’s late day sell-off in the US was followed with modest Asian weakness (Nikkei -0.2%, Hang Seng -0.35%, Shanghai 0.0%) although European bourses have held onto modest gains.  Right now, the FTSE 100 (+0.7%) is leading the way (remember, a weaker pound typically helps the FTSE), with the CAC (+0.3%) and DAX (+0.1%) showing much less promise.  As to US futures, they are very little changed at this hour with no real information from their movement of a few points in either direction.

Bond markets, however, are a little more consistent, generally rallying slightly with yields edging lower.  The biggest mover are UK Gilts, with 10-year yields lower by 5.7 basis points as investors and traders are betting on a weaker UK economy with a no-deal outcome.  After that, the PIGS are doing well, with yields lower between 2-4 bps, as visions of further ECB purchases dance in investors’ heads.  Treasuries are moving in the same direction, but the 1 basis point decline in yield is hardly game-changing.

Commodity markets continue their confusing ways, this time with oil rallying slightly, (WTI
+1.5%) while gold is declining, -0.3%.  And finally, the dollar is having, what can only be described, as a mixed session.  In the G10, the pound has actually extended its early losses and is now down -1.0%.  As well, JPY (-0.3%) is also weaker despite (because of?) what seemed to be pretty reasonable manufacturing data overnight.  The rest of the bloc, however, is firmer vs. the dollar led by AUD (+0.6%) on the back of rising iron ore prices, although the gains fall away to much more modest outcomes beyond that.  CAD (+0.3%) seems to be benefitting from the rise in oil prices but nothing else is even noteworthy.

Emerging market currencies are also mixed, with the gainers led by BRL (+0.8% on the open) after the central bank left rates on hold last night, as universally expected, but also explained that the pledge to keep rates at that level may be coming to an end as inflation starts to rise in the country.  This was taken as quite hawkish, so I would look for further BRL appreciation going forward.  Elsewhere on the plus side is RUB (+0.45%) clearly benefitting from oil’s rise, and HUF (+0.35%) which continues to benefit from the EU budget deal.  On the downside, ignoring TRY, ZAR (-0.4%) is the worst performer, seeming to suffer from a surge in Covid cases, with KRW (-0.3%) seeming to feel the pressure of yesterday’s tech stock sell-off in the US.

We finally get some data of note this morning led by the weekly Initial Claims (exp 725K) and Continuing Claims (5.21M) data.  But we also see the latest reading on headline CPI (0.1%, 1.1% Y/Y) and core (0.1%, 1.5% Y/Y).  The great inflation/deflation debate continues amongst the economic community with the deflationists continuing to point to the data as their trump card, but the inflationists continuing to point to real life.  My money is on inflation, probably as soon as next year, that is far higher than the Fed currently anticipates.

And that’s really it for the day.  All eyes will be on the tape at 7:45 when the ECB releases their statement, and then Madame Lagarde will be on camera starting at 8:30am.  Barring a breakthrough on Brexit today (which seems highly unlikely) the pound seems to have room to fall further.  As to the euro, that is in Lagarde’s hands.  And the dollar in general?  The recent slow trend lower remains intact, and I wouldn’t start that fight quite yet.

Good luck and stay safe