Tag Archives: #Brexit

What Exactly Comes Next?

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Though Boris did garner a win
Another act’s caused him chagrin
The latest delay
Has kept the UK
Adrift ‘midst an increasing din

The question that has markets vexed
Is just what exactly comes next?
Elections? Could be
And likely a plea
To quantify Brexit’s effects

Brexit noun
brē·gzit

Definition of Brexit
“It is a tale told by an idiot, full of sound and fury, signifying nothing.”

Clearly, William Shakespeare was a man ahead of his time! The Brexit saga continues although it seems to have turned from drama to comedy. However, that is far better than the tragedy that could have come about in the event of a no-deal outcome. At this point, it seems the most likely outcome will be another three-month delay, with January 31st mooted as the target now, to allow the UK to finally (?) solve their internal dilemma. Yesterday’s activity saw Boris win the first vote, which means that he had sufficient support, in principal, for the deal he renegotiated with the EU. However, his attempt to force the second and third readings to occur today and tomorrow such that a final vote could be held was thwarted. Thus, while Parliament has approved what he has done, and that occurred despite lacking DUP support, they want more time to ponder the bill, and likely lard it with amendments for each group’s individual constituencies. Thus, the discussion now is the EU will grant a flexible delay, meaning January 31 is the target, but that if the UK can solve their internal arguments sooner, the date would be moved up.

While I continue to believe that this has played into Boris’s strength, and that any election will see him re-elected with a thumping majority, that remains unclear. But what is clear is that the FX market has adjusted its views on the potential outcomes. At this point I would suggest there are three possible results; a no-deal Brexit; passage of the current deal; or a vote and then new referendum which leads to a Remain victory and no Brexit at all. If we assume the following movements are realistic outcomes:

No-deal => 1.10
Current deal => 1.30-1.35
Remain => 1.45

Then the market has reduced the probability of a no-deal to just 15%, which is substantially lower than what had certainly been at least a 50% probability just a few weeks ago, while the probability of the deal being enacted has risen to nearly 80%, and a Remain outcome just 5%. While hardly scientific, this is one possible explanation for the current level, as well as a possible view of where the pound can go given those three end results. Don’t forget the salt!

A quick look at the pound this morning shows that it has fallen ever so slightly from yesterday’s closing level, just 0.1%, and that it remains quite volatile within its current trading range. My view is that an extension and a successful call for an election will lead to further cable strength as it will reduce the probability of a no-deal outcome even further. In fact, we could well see a growing view that a second referendum will be held and most recent polls seem to imply no Brexit at all. In that event, I think the pound can go much higher, at least until the market starts to pay closer attention to the entire EU’s deteriorating economic fundamentals and the reality that investment inflow is going to be lacking, while outflows pick up. Ultimately, I continue to see the dollar performing well, but for the pound, we may need a reset of the base level given everything that has occurred.

Turning to the rest of the G10 space, the dollar is firmer vs. 9 of them with only the yen holding up today. However, the magnitude of that strength has been extremely modest, averaging about 0.1%. In other words, not much is happening. The same is largely true in the EMG bloc, although the biggest gainer has been TRY with traders shaking off the ongoing Kurdish fighting and seemingly responding to an improvement in Consumer Confidence there. On the negative side, ZAR is under the gun today, down 0.8%, after lower than expected CPI readings (4.1%, 4.0% core) indicated that the SARB will be less aggressive tightening monetary policy, or perhaps, more aggressive loosening it.

In fact, today has all the hallmarks of a modest risk-off session as we have seen both Treasury and Bund yields slip about 3bps, gold prices rise 0.35% and equity markets come under pressure after earnings data has shown at least as many disappointments as beats. As I type, US futures are lower by 0.3% while there is weakness in the CAC (-0.6%) and both Italian and Spanish markets, and the DAX is the outperformer at unchanged on the day.

On the data front, yesterday’s Home Sales were mildly disappointing, falling a more than expected 2.2%, and there is nothing of real note this morning. That points to a day where absent a tweet from the White House, or a significant change in the Brexit debate in Parliament, FX will take its cues from the equity market and the ongoing earnings releases. The better the earnings, the more likely that risk will make a comeback and the dollar drift lower. The reverse is also true. But in the end, we are all beholden to other catalysts while we await next week’s FOMC meeting.

Good luck
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Kind of a Treat

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For Boris, what looked like defeat
Is actually kind of a treat
For later today
His bill makes its way
Through Parliament, it to complete

The Brexit drama continues today, but it has become clear that Boris is moving toward a win, politically at least. The schedule today is for Parliament to debate and then hold its first vote on the actual legislation that would put Brexit into law. When Speaker of the House Bercow would not allow a second vote on the broad idea of accepting the new terms, it forced the PM to set out the new law’s details for a vote. And that is exactly what he has done. The goal is to get final approval by Thursday evening in the House of Commons, at which point it will go to the House of Lords for final approval. While the Lords have not been supportive of Brexit overall (after all, they have all benefitted greatly from the current situation) if it passes the House of Commons, it is expected to pass there as well. It is unquestionable that if this schedule holds up, the EU will pass the bill as well, and Brexit will be complete.

While there are still many potential pitfalls, the market has become pretty clear that they no longer believe in the idea of a no-deal Brexit. That is why we remain hovering around the 1.30 level instead of the 1.22 level we saw for most of the summer, when it seemed that all Boris wanted was to leave, and he was willing to leave without a deal. But even if there is a delay, it seems to me that Boris has the upper hand in any election that comes. He has done what he promised, negotiated a new treaty with a substantially better outcome than former PM May’s Irish backstop. The new bill puts the power of remaining tied to the EU in the hands of Northern Ireland, not the EU. There may yet be a second referendum, and there will almost certainly be an election before the end of the year, but at this point, Boris outflanked all the opposition. I strongly believe that a negotiated Brexit is coming to a screen near you before the year ends, and that the pound is going to have an opportunity to rally much further. At this point, a move to between 1.35-1.40 seems quite probable, although eventually I expect the dollar to reassert itself globally.

However, this is all speculation about the future, albeit the near future. For today, though, FX markets have continued to digest the news and the pound has been trading either side of yesterday’s closing levels. Currently, it is unchanged on the day, although there is an opportunity for movement this afternoon as the bill wends its way through Parliament’s byzantine process. At approximately 2:00pm, a vote is expected which will determine if the new bill has a chance to get passed. I think a ‘no’ vote will have a temporary negative impact on the pound, but am hard pressed to see Sterling sink below 1.28. If the vote is yes, then look for the pound to start to appreciate further as the market anticipates a conclusion to the process soon.

Away from Brexit, President Trump hinted that the ongoing trade talks are moving in the right direction and the market has assumed that the “initial phase” deal will be signed at the APEC meeting in Chile next month when presidents Trump and Xi are scheduled to meet.

So combined with the positive Brexit vibes, it appears two of the key geopolitical issues that have been hindering the global economy may be coming to a positive resolution. That certainly bodes well for economic growth, but it is unclear if it will be enough to turn the tide. First, neither one is actually complete yet, so this is all anticipation; and second, we have seen a significant slowdown in global manufacturing that will not simply rebound instantly. Even if business confidence improves sharply, it still takes time to formulate and implement new plans for business expansion. This implies that the current monetary policy framework is not going to be reversed any time soon.

Speaking of monetary policy, Thursday Signor Draghi presides over his last meeting as ECB president. After last month’s rate cut and restarting of QE, there are no expectations for further actions at this meeting. The one thing of which you can be sure is that he will complain about the lack of fiscal stimulus being implemented by the nations that can afford it (read Germany). But you can also be sure that the Germans are not about to change their plans.

But let us discuss one of the key problems in the Eurozone for a moment, the inconsistency between fiscal dogma and political will. While it is now de rigeur to claim that nations need to turn on the fiscal pumps, the European Commission has sent letters to Italy, France, Spain, Belgium and Portugal telling them not to spend so much money next year. In other words, despite desperate pleas to increase spending, they are going to prevent five nations seeking to do so, from accomplishing their goals. If you ever wondered why there is such fundamental bearishness on the euro and its construction, this situation could not be more informative. It is a key reason I believe the long term prospects for the single currency point lower.

To markets: FX has had another generally dull session overnight with the dollar just slightly firmer against most counterparts, but with movements generally less than 0.20%. In other words, there is little if any information in the price movement, which is likely a response to recent dollar weakness. Equity markets in Asia flourished after the US rally yesterday, but in Europe they can only be described as mixed. Meanwhile, US futures are pointing slightly lower, although not enough to imply very much. Treasury yields are a few bps lower, as are Bund yields, but the reality is that they have been pretty stable for the past two weeks and traders seem to be looking for the next real catalyst (FOMC anyone?).

Yesterday’s Canadian election had little impact on the Loonie, although PM Trudeau is returning with a weakened mandate in a minority government. That said, north of the border the economy has been performing pretty well, certainly well enough such that there seems to be no reason for the BOC to follow the Fed and cut rates next week alongside the Fed.

As to data this morning, Existing Home Sales (exp 5.45M) are unlikely to quicken any pulses, and with the Fed in its quiet period, quite frankly, I see a very quiet session until this afternoon, when the results of the first Brexit votes in parliament have an opportunity to spice things up a bit.

Good luck
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Make Boris Bend

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As Parliament seeks to extend
The timeline, and make Boris bend
The market’s decided
The deal he provided
Will ultimately pass in the end

Well, Brexit is still the number one topic in markets, although after a quiet Friday on the trade front, we got more discussion there as well. As to Brexit, Boris lost his fight to get a clean vote on the newly renegotiated deal on Saturday. Instead, Parliament voted to force a request for an extension, which at this moment the EU is considering. Interestingly, in the EU there are a number of countries that seem ready to be done with the process and no longer care if the UK exits. However, as sweet as that would be for the Brexiteers, in the end that would require courage by the country(ies) who voted no. And courage is something in short supply at the top of European (and most) governments. At any rate, given the speed with which this story changes, this morning the word is that Johnson has found the votes necessary to get his deal through Parliament, but it means that he has to get another vote. The roadblock there is in the form of John Bercow, the Speaker of the House of Commons, who has proven himself to be a virulent Bremainer, and wants nothing more than to see Boris fail.

With that as background, one might have thought the pound would have suffered, but the market has looked through all the permutations and decided that a deal is forthcoming in the near-term, or perhaps more accurately, that the odds of a no-deal Brexit have been significantly reduced. This is evident in the fact that as I type, the pound is essentially unchanged since Friday’s optimistic close at 1.2980, and has traded above 1.30 earlier in the session for the first time since May (the month, not the former PM).

However, I think the euro’s performance has been far more interesting lately. Consider that despite an ongoing run of generally awful data, showing neither growth nor inflationary impulse, the single currency continues to climb slowly. A part of this is likely a result of what has been mild dollar weakness amid increasing risk appetite. But I think that the market has also begun to recognize that a Brexit deal will remove uncertainty on the continent and the euro will benefit accordingly. From the time of the referendum in 2016 I have made it clear that Brexit was not just a British pound story, but a euro one as well. And this slow appreciation (EUR is higher by 2.7% this month, about 0.7% more than the dollar index) is a belated reaction to the fact that a Brexit deal is a benefit there as well. At any rate, much of this story is yet to be written, and a successful outcome will almost certainly result in further GBP outperformance, but the euro is likely to continue this grind higher as well.

On the trade front, comments from Chinese vice-premier Liu He explaining China would work with the US to address each other’s core concerns and that ending the trade war would be good for everyone were seen as quite positive by equity and other risk markets. In fact, the combination of optimism on the two big issues of the day, trade and Brexit has led to a clear, if modest, risk-on session. Equity markets in Asia performed well (Nikkei +0.25%, CSI 300 +0.3%), and we are seeing modest gains throughout Europe as well (DAX +0.7%, CAC +0.15%). It is certainly a positive that the trade dialog continues, but I fear we remain a very long way from a broad deal.

Another weekend event was the World Bank / IMF meetings in Washington with the commentary exactly what you would expect. Namely, everyone derided the trade war and explained it would be better if it ended. Everyone derided Brexit and said it would be better if it didn’t happen. And everyone explained that it’s time for fiscal policy to step up to the plate to help central banks. What has become very clear is that central banks are truly running out of room to help support their respective economies but it is impolitic to say so. This results in exhortations for fiscal policy pushes by those who can afford it. However, Germany remains resolute in their belief that there is no reason to implement a supplementary budget of any kind and that continuing to run a budget surplus is the best thing for the nation. Look for pressure to continue to build, but unless growth really starts to crater there, I don’t expect them to change their views, or policies.

A look around the rest of the FX market shows that the biggest gainer this weekend was KRW, rising 0.8% on optimism that a trade deal between the US and China was closer. Certainly it was not the terrible data from South Korea that helped the won rally, as exports in October have fallen nearly 20%, making eleven consecutive monthly declines in that statistic. Otherwise, the mild risk-on atmosphere has helped most EMG currencies edge higher. On the G10 front, NOK is the big winner, rising 0.55%, although that simply looks like a reaction to its sharp declines over the past two weeks.

On the data front it is extremely quiet this week as follows:

Tuesday Existing Home Sales 5.45M
Thursday Initial Claims 215K
  Durable Goods -0.7%
  -ex Transport -0.3%
  New Home Sales 701K
Friday Michigan Sentiment 96.0

Source: Bloomberg

Arguably, Durable Goods is the most interesting number of the bunch. And after a two-week deluge of Fed speakers, they have gone into their quiet period ahead of next Wednesday’s meeting. The final comments by Kaplan and Clarida were similar to the previous comments we heard, namely that the economy is in a “good place” and that they are essentially going to play it by ear on the next rate decision. As of this morning, the market is still pricing in an 89.5% probability of a rate cut.

Speaking of low rates, Signor Draghi presides over his last ECB meeting this week and while there are no new policies expected, it is universally anticipated that he will renew his call for fiscal stimulus to help the Eurozone economic outlook. Quite frankly, I think it is abundantly clear that the ECB has completely run out of ammunition to fight any further weakness, and that Madame Lagarde, when she takes the seat on November 1, will feel more like Old Mother Hubbard than anything else.

For the day, I see no reason for the risk-on attitude to change, and if anything, I imagine we can see more positive news from the UK which will only help drive things further in that direction. While in the end, I still see the dollar performing well, for now, it is on its back foot and likely to stay there for a little while longer.

Good luck
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Pledges Bestowed

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In China, the pace of growth slowed
Which highlighted how hard the road
Is going to be
For President Xi
To live up to pledges bestowed

With the Brexit situation now up to Boris Johnson’s domestic political machinations, finding the required 326 votes to pass his agreed deal with the EU, the market’s attention has turned elsewhere. It should be no surprise that China is the topic, this time based on the data released last night. While the trajectory of growth in China has been slowing quite consistently for the past ten years, last night’s 6.0% GDP result was weaker than expected and indicates that perhaps, that slowdown is accelerating. Alongside the GDP data, the other three key monthly data points; IP (5.6% YTD), Fixed Asset Investment (5.4% YTD), and Retail Sales (8.2% YTD) showed a mixed bag versus expectations, although generally all point to continuing slower growth. The trend in China is downward. On the one hand, this should not be surprising. After all, the larger the base size of an economy, the harder it is to grow rapidly. On the other hand, despite significant government control over the entire economy, it is becoming clear that the combined fiscal and monetary stimulus measures China is using are, so far, not up to the job of upholding President Xi’s targets.

Regarding the trade talks, this simply adds to pressure on Xi to find a deal. Despite his title as President for Life, there are clearly still many domestic political issues with which he must deal, and failure to bring about promised growth will be quite problematic. As many pundits have already described, the reality is that both sides need a deal given the fact that the eighteen month long trade spat has started to drag down both the US and China in terms of GDP growth. Interestingly, the PBOC fixed the renminbi stronger last night, although both the onshore and offshore yuan are trading weaker by about 0.1% this morning. Overall, though, the trend for the renminbi has been for modest weakening over time. Regardless of promises to manage the currency, the reality remains that China needs their currency to weaken as a relief valve for internal pressures. An interesting aside is that there is some evidence based on the errors and omissions portion of the Chinese accounts, that capital continues to flow out of China pretty aggressively, despite the capital controls imposed in the summer of 2015. Eventually, if that is true, USDCNY is going to go higher. I continue to look for an eventual move toward 7.40, but it may take longer than the end of this year as I previously thought.

However, beyond the Chinese data story, FX has been a pretty uneventful place to be overnight. G10 currencies are generally slightly firmer vs. the dollar, but we are only looking at the biggest mover, SEK, having rallied 0.3% this morning after a more substantive 1.3% rally yesterday. It seems that despite higher than expected unemployment data, there is concern that data may be faulty and the Riksbank may still have room to raise interest rates at their next meeting, or by the end of the year at the very least. But away from that story, there is nothing of real note in the G10 space.

And in truth, that is pretty much the situation in the EMG space as well. TRY is the leading gainer, higher by 0.85% after the cease-fire on the Syrian border went into effect. Elsewhere, both ZAR and KRW are firmer by 0.5% with the won benefitting from comments by Treasury Secretary Mnuchin that he may request an auto tariff exemption for South Korea. Meanwhile, the rand is the beneficiary of profit-taking after recent weakness in the currency, as traders and investors await the latest information on the Eskom situation in a government briefing later today.

For the rest of the day, while we wait to hear any tidbits from the UK, there is only one data point, Leading Indicators (exp 0.0%), and then we hear from three more Fed speakers, the uber-hawk, Esther George, as well as Richard Clarida and Robert Kaplan. So far this week we have heard the consistent message that the FOMC is watching the data closely but has not yet made up their mind if another cut is necessary right away.

In truth, it is shaping up to be an uneventful day to finish the week. The dollar is a bit soft, equity futures are little changed, as are equity markets throughout Europe, and Treasury yields are within 1bp of yesterday’s levels. Unless there is a tape bomb, it is hard to see a reason for a big more from current levels.

Good luck and good weekend
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Can Boris Succeed?

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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.

Good luck
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Lost Their Zeal

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While yesterday Brexit seemed real
As both sides looked close to a deal
This morning we hear
A deal’s not so near
As Ireland’s North lost their zeal

Meanwhile from the Far East, the news
Is that China just might refuse
To buy pork and grain
Unless we refrain
From publicly airing our views

While the same two stories remain atop the leaderboard, the score has clearly changed. This morning, much of yesterday’s Brexit optimism has dissipated as the DUP, Boris Johnson’s key Northern Irish ally in Parliament, explained they could not support the deal that Johnson has been furiously negotiating over the past few days. Remember, DUP stands for Democratic Unionist Party, and the Union of which they speak is that of Northern Ireland and the rest of the UK. As such, they cannot countenance the idea of a soft border in the Irish Sea between Northern Ireland and the rest of the UK. They want to be treated exactly the same. At the same time, they don’t want a hard border between themselves and the Republic of Ireland, so it seems that they are the ones that need to make up their collective mind. As time is very clearly running out, the conversation has reached a very delicate phase. Remember, the Benn Act requires PM Johnson to request an extension by this Saturday if there is no deal agreed, and of course, Boris has said he “would rather be dead in a ditch” than request such an extension.

From what I have read, it appears that the soft border would be time limited, and so in the end, I think the pressure on the DUP will be too great to bear and they will cave in. After all, they also don’t want to be the ones responsible for the failure of reaching a deal. The pound, after having traded as high as 1.2800 yesterday, has been extremely volatile this morning, trading in a more than 1.0% range and having touched both the highs at 1.2790 and the lows near 1.2660 twice each. As I write, the pound is lower by 0.3% on the day, but at this point, it is entirely headline driven. The one thing that is clear is that many of the short positions that had been built up over the past year have been reduced or eliminated completely.

Turning to China, the story is about Beijing’s anger over two bills passed by the House of Representatives in support of the pro-democracy protests in Hong Kong. The Chinese are adamant that anything that happens in Hong Kong is a domestic affair and that everybody else, especially the US, should keep their noses out of the discussion. In fairness, it is a Chinese territory legally, unlike the situation in Taiwan where they claim ‘ownership’ with less of a legal claim. Nonetheless, they are quite serious and are threatening retaliation if any law addressing Hong Kong is passed by the US. Now a bill passing the House is a far cry from enacting a law, but this does seem to be something where there is bipartisan support. Remember, too, that the standoff with China is one of the few things where the Democrats and President Trump see eye to eye.

At the same time, somewhat behind the scenes, the PBOC injected CNY 200 billion into its money markets last night, surprising everyone, as a measure of further policy ease. Thursday night the Chinese will release their Q2 GDP data and while the median forecast is for a 6.1% annualized outcome, there are a number of forecasts with a 5 handle. That would be the slowest GDP growth since at least 1992 when records started to be kept there. At any rate, the cash injection helped weaken the renminbi with CNY falling 0.3% in the overnight session. One thing to remember here is that part of the ostensible trade deal is the currency pact, but if that deal falls apart because of the Hong Kong issue, it opens the door for CNY to weaken a bit more.

It ought not be surprising that the change in tone on those two stories has dampened overall market enthusiasm and this morning can clearly be described as a risk-off session. In the G10, the dollar is stronger against everything except the yen and Swiss franc (both higher by 0.1%). In fact, both NOK (-0.9%) and NZD (-0.7%) lead the way lower with the former responding to oil’s ongoing weakness as well as the potential negative impact of a hard Brexit. Meanwhile, the kiwi has suffered after the RBNZ reiterated that lower rates were likely still in store despite CPI printing a tick higher than expected last night at 1.5%.

In the EMG space, things have been less dramatic with ZAR today’s weakest component, falling 0.5% after news that the troubled utility, Eskom, will be forced to create rolling blackouts, further highlighting its tenuous financial position and putting more pressure on the government to do something (read spend money they don’t have) to fix things. Without a solution to this issue, which has been hanging over the economy for several years, look for the rand to continue its broad move lower. While at 14.97, it is well off the lows seen in August, the trend remains for the rand to continue falling. Otherwise, this space has been far less interesting with KRW dipping just 0.25% overnight after the BOK cut rates by 25bps. The thing is, comments from BOK members indicated a reluctance to cut rates much further, thus limiting the downward movement.

This morning brings us Retail Sales (exp 0.3%; -ex autos 0.2%) and Business Inventories (0.2%). Then, at 2:00 the Fed’s Beige Book is released with analysts set to look for clues about economic activity to drive the Fed’s next activity. We also hear from three Fed speakers, Evans, Kaplan and Brainard, who all lean to the dovish side of the spectrum. With European equities under pressure and US futures pointing lower, it seems that risk will remain out of favor, unless there is a change of heart in the UK. But for now, think risk-off as a guide to today’s activity.

Good luck
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Talks Remain Tough

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In Brussels they’re starting to say
A soft Brexit’s soon on the way
Though talks remain tough
There could be enough
To reach an agreement today!

Nothing has changed with regard to which stories are market drivers, although on the equity front we now get to add Q3 earnings to the mix. But as far as FX is concerned, Brexit and trade still dominate the discussion. Regarding Brexit, the rumblings from Brussels have been far more positive this morning, with the EU’s chief negotiator, Michel Barnier, explaining that a deal was still possible before the EU Summit on Thursday, but difficult. Apparently, the UK has submitted detailed plans of how they would like to address the Irish border situation, and there is serious consideration although negotiations continue. From Parliament, the word is that the votes will be there to pass any deal agreed by PM Johnson, as the Tories and Brexiteers recognize that Boris was a Brexiteer from the get-go. The Summit begins in two days, and I continue to expect that a deal, ‘in principal’ will be agreed beforehand. It should be no surprise that the pound has rallied on the news, after giving up some of Friday’s gains during the European session yesterday. This morning, Sterling is higher by 0.4%, although since we closed Friday, it is actually lower by 0.2%. Nonetheless, I continue to see scope for significant advancement here upon the news that deal has been reached.

As to the trade story, Friday also proved to be something of a false dawn as the Chinese backed away from the idea that a deal has been struck and are seeking continued discussions. This morning, however, there seems to be a bit more upbeat tone, even with the Chinese, as it is clear that talks will continue over the next few weeks at both mid-level and high-level (Mnuchin, Lighthizer and Liu He) conference calls. The Chinese have also figured out that they need to import a LOT if pork and that is something of which the US possesses a great deal. Overnight, Chinese data showed PPI falling 1.2%, meaning factories continue to lose pricing power, but CPI rose 3.0%, above expectations and starting to put pressure on the government. As part of that CPI rise, pork prices rose 69%! African swine fever is clearly taking its toll on the Chinese swine herd. This morning, the Chinese offered to remove tariffs on $50 billion of agricultural products if the US would remove a similar amount. While no decision has been made, I expect that there will be agreement on this subject as for President Trump, the demographics of the beneficiaries of this action would be his biggest supporters. Despite broad dollar strength since Friday, we continue to see the renminbi (+0.2% since Friday) perform well, a testimony to the PBOC’s efforts to prevent the currency from weakening, but also in response, I think, to the idea that there is positive movement on the trade front.

Away from those stories, we continue to see weak Eurozone growth data, with the German ZEW Survey falling to -22.8, slightly better than expected but still miles below its longer term average of +12.8. On top of that, a survey of 53 economists by Bloomberg has forecast that German GDP will shrink 0.1% in Q3, defining a technical recession in the country, and weighing further on the entire Eurozone. As I have repeatedly pointed out, the EU cannot afford a hard Brexit and are highly incented to reach an agreement this week. The euro, which had been holding its own of late has given up 0.2% this morning and a bit more since Friday and is back at the 1.1000 level, although that is in the upper half of performers in the G10 space. The biggest loser is NZD, which is down 1.1% since Friday after the RBNZ bid for bonds, which traders read as a form of QE, and which is tracking Aussie lower after remarks from the RBA indicate that further easing is on the way.

The other big loser this morning is the Norwegian krone, which has fallen 0.8% since Friday following oil prices’ downward trajectory. The latter is due to a combination of concerns over slowing global growth reducing demand for oil, while inventories continue to rise.

In the EMG space, INR is today’s largest mover, sliding 0.75% after CPI data was released at a higher than expected 3.99% in September. The rupee had been a beneficiary of inward investment based on the idea that quiescent inflation would allow further RBI rate cuts and enhanced growth and equity market performance. However, if inflation has bottomed, it seems that investors are likely to be a little more circumspect. Overnight there was clear selling of Indian bonds by international investors leading to the currency’s decline. However, beyond that movement, the EMG bloc had more losers than gainers, but none with a significant move or story.

On the data front this week, we see a bunch of middle tier data with the highlight arguably Retail Sales.

Wednesday Retail Sales 0.3%
  -ex autos 0.2%
  Business Inventories 0.2%
  Fed’s Beige Book  
Thursday Initial Claims 215K
  Housing Starts 1320K
  Building Permits 1350K
  Philly Fed 8.0
  IP -0.2%
  Capacity Utilization 77.7%
Friday Leading Indicators 0.1%

In addition to the data, we hear from a total of ten Fed speakers this week, ranging from the uber-dove James Bullard to the uber-hawk Esther George and every spot along the spectrum in between. Overall, the Fed message has been that they feel the economy is in a ‘good’ place, but they won’t hesitate to ease further if the data turns downward. Of course, their message was also that buying $60 billion / month of T-bills to help ease reserve conditions was in no way more QE. That is a much tougher circle to square.

Looking ahead, the market remains headline driven so care needs to be taken. There is no clear risk view this morning with both equity futures and Treasuries higher, and the dollar is mixed, again clouding any view. My expectation is that the market will likely tread water ahead of the next piece of news. And my money remains on that being a positive Brexit story.

Good luck
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Time’s Crunch

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When Boris and Leo had lunch
No panties were balled in a bunch
The signals showed promise
And no doubting Thomas
Appeared, as both sides felt time’s crunch

Meanwhile, though there’s been no bombshell
The trade talks have gone “very well”
Today Trump meets He
And then we will see
If a deal betwixt sides can now gel

And finally from the Mideast
The story ‘bout risk has increased
A tanker attack
Had market blowback
With crude a buck higher at least

There is no shortage of important stories today so let’s jump right in. Starting with Brexit, yesterday’s lunch meeting between Boris Johnson and Leo Varadkar, the Irish PM, turned into something pretty good. While the comments have been very general, even EU president Donald Tusk as said there were “promising signals.” It is crunch time with the deadline now less than three weeks away. Apparently, the rest of the EU is beginning to believe that Boris will walk with no deal, despite the Benn Act requiring him to ask for an extension if there is no deal in place. At the same time, everybody is tired of this process and the EU has many other problems, notably a declining economy, to address. And so, I remain confident that we will soon hear, probably early next week, about a ‘deal in principle’ which will be ratified by Parliament as well as the EU. Though all the details will not have been completed, there will be enough assurances on both sides to get it through. Remember, Boris has Parliament on his side based on the deal he showed them. I’m pretty sure that his conversation with Leo yesterday used that as the starting point.

When that news hit the tape yesterday morning a little past 10:00, the pound started a significant rally, ultimately gaining 2% yesterday and it is higher by a further 1.0% this morning after more promising comments from both sides of the table. Remember, too, that the market remains extremely short pound Sterling and has been so for quite a while. If I am correct, then we could see the pound well above 1.30 as early as next week. Of course, if it does fall apart, then a quick trip back to 1.20 is on the cards. As I have said, my money is on a deal. One other thing to note here is what happened in the FX options market. For most of the past twelve years, the risk reversal (the price the market pays for 25 delta puts vs. 25 delta calls) has traded with puts at a premium. In fact earlier this year, the 1mo version was trading at a 2.5 vol premium for puts. Well, yesterday, the risk reversal flipped positive (bid for calls) and is now bid more than 1.0 vol for GBP calls. This is a huge move in this segment of the market, and also seen as quite an indicator that expectations for further pound strength abound.

Regarding the trade talks, risk assets have taken a very positive view of the comments that have come from both sides, notably President Trump describing things as going “very well” and agreeing to meet with Chinese Vice-premier Liu He this afternoon before he (He) returns to Beijing. The information that has come out points to the following aspects of a deal; a currency pact to insure the Chinese do not weaken the renminbi for competitive advantage; increased Chinese purchases of grains and pork; a US promise not to increase tariffs going forward as the broader negotiations continue; and the lifting of more sanctions on Chinese companies like Huawei and COSCO, the Chinese shipping behemoth. Clearly, all of that is positive and it is no surprise that equity markets globally have responded with solid gains. It is also no surprise that Treasury and Bund yields are much higher this morning than their respective levels ahead of the talks. In fact, Treasuries, which are just 1bp higher this morning, are up by more than 15bps since Tuesday. For Bunds, today’s price action shows no change in yields, but a 12bp move (less negative rates) since then. The idea is a trade deal helps global economic growth pick back up and quashes talk of deflation.

The last big story of the morning comes from the Persian Gulf, where an Iranian oil tanker, carrying about 1 million barrels of oil, was attacked by missiles near the Saudi port of Jeddah. At first the Iranians blamed the Saudis, but they have since retracted that statement. It should be no surprise that oil prices jumped on the news, with WTI futures quickly rallying more than a dollar and maintaining those gains since then. One of the key depressants of oil prices has been the global economic malaise, which does not yet look like it is over. However, if the trade truce is signed and positive vibes continue to come from that area, I expect that oil prices will benefit greatly as well.

As to the FX market per se, the dollar is overall under pressure. Of course, the pound has been the biggest mover in the G10 space, but AUD has gained 0.55% and the rest of the block is higher by roughly 0.3%. The only exceptions here are the yen (-0.3%) and Swiss franc (-0.1%) as haven assets are unloaded.

Turning to the EMG bloc, ZAR is today’s big winner, rallying more than 1.1% on two features; first the general euphoria on trade discussed above and second on the news that former President Jacob Zuma must face corruption charges. The latter is important because it demonstrates that the rule of law may be coming back into favor there, always a benefit for an emerging market. But most of the space is firmer this morning, with many currencies higher by between 0.5% and 0.6% (RUB, KRW, PLN, HUF, MXN, etc.) In fact, the only loser this morning is TRY (-0.4%), which remains under pressure as President Erdogan presses his military campaign against the Kurds in Syria.

On the data front, the only US news is Michigan Sentiment (exp 92.0) but we also get the Canadian employment picture (exp 7500 new jobs and a 5.7% Unemployment Rate). Three more Fed speakers, Kashkari, Rosengren and Kaplan, are on the slate, but so far, the only clarity of message we have received this week is that everybody is watching the data and will respond as they see fit. Hawks are still hawks and doves are still doves.

I see no reason for the dollar to regain ground today assuming the good news from Trade and Brexit continue. So look for a further decline into the holiday weekend.

Good luck and good weekend
Adf

PS. While typing, the pound jumped another 1.0%.

Too Effing High

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Said Powell, we’re going to buy
More assets in order to try
To make sure that rates
Stay where the Fed states
And stop trading too effing high

“This is not QE; in no sense is this QE!” So said Fed Chairman, Jerome Powell, yesterday at a conference in Denver when describing the fact that the Fed would soon resume purchasing assets. You may recall right around the time of the last FOMC meeting, there was sudden turmoil in the Fed Funds and other short-term funding markets as reserves became scarce and interest rates rose above the Fed’s target. That resulted in the Fed executing a series of short-term reverse repos in order to make more reserves available to the banking community at large. Of course, the concern was how the Fed let itself into this situation. It seems that the reduction of the Fed balance sheet as part of the normalization process might have gone a little too far. Yesterday, Powell confirmed that the Fed was going to start buying 3-month Treasury bills to expand the size of the balance sheet and help stabilize money markets. However, he insisted that given the short-term nature of the assets they are purchasing, this should not be construed as a resumption of QE, where the Fed bought maturities from 2-years to 30-years. QE was designed to lower longer term financing rates and boost investment and correspondingly economic growth. This action is meant to increase the availability of bank reserves in the system so that no shortages appear and money markets remain stable and functioning.

As far as it goes, that makes sense given commercial banks’ regulatory needs for a certain amount of available reserves. But Powell also spoke about interest rates more generally and hinted that a rate cut was a very real possibility, although in no way certain. Of course, the market is pricing in an 80% probability of a cut this month and a 50% probability of another one in December. Certainly Powell didn’t dispute those ideas. And yet a funny thing happened in the markets yesterday despite the Fed Chairman discussing further policy ease; risk was reduced. Equity markets suffered in Europe and the US, with all major indices lower by more than 1.0% (S&P -1.5%). Treasury yields fell 3bps and the dollar rallied steadily all day along with the yen, the Swiss franc and gold.

It is the rare day when the Fed Chair talks about easing and stock prices fall. It appears that the market was more concerned with the escalation in trade war rhetoric and the apparent death of any chance for a Brexit deal, both of which have been described as key reasons for business and investor uncertainty which has led to slowing growth, than with Fed policy. And for central banks, that is a bigger problem. What if markets no longer take their cues from the central bankers and instead trade based on macroeconomic events? What will the central banks do then?

On the China front, yesterday’s White House actions to blacklist eight Chinese tech firms over their involvement in Xinjiang and the Uigher repression was a new and surprising blow to US-China relations. In addition, the US imposed visa restrictions on a number of individuals involved in that issue and has generally turned up the temperature just ahead of the next round of trade talks which are due to begin tomorrow in Washington. It has become abundantly clear that the ongoing trade war is beginning to have quite a negative impact on the US economy as well as that of the rest of the world. President Trump continues to believe that the US has the advantage and is pressing it as much as he can. Of course, Chinese President Xi also believes that he holds the best cards and so is unwilling to cave in on key issues. However, this morning there was a report that China would be quite willing to sign a more limited deal where they purchase a significantly greater amount of agricultural products, up to $30 billion worth, as well as remove non-tariff barriers against US pork and beef in exchange for the US promising not to implement the tariffs that are set to go into effect next Tuesday and again on December 15. In addition, the PBOC fixed the renminbi last night at a lower than expected 7.0728, indicating that they want to be very clear that a depreciation in their currency is not on the cards. It is not hard to view these actions and conclude that China is starting to bend a little, especially with the Hong Kong situation continuing to escalate.

It also seems pretty clear that the talks this week have a low ceiling for any developments, but my sense is some minor deal will be agreed. However, the big issues like state subsidies and IP theft are unlikely to ever be resolved as they are fundamental to China’s economic model and there are no signs they are going to change. In the end, if we do get some de-escalation of rhetoric this week, I expect risk assets to respond quite favorably, at least for a little while.

Turning to Brexit, all we have heard since yesterday’s phone call between Boris and Angela is recriminations as to who is causing the talks to fall apart. Blame is not going to get this done, and at this point, the question is, will the UK actually ask for an extension. Ostensibly, Boris is due to speak to Irish PM Varadkar today, but both sides seem pretty dug in right now. The EU demand that Northern Ireland remain in the EU customs union in perpetuity appears to be a deal breaker, and who can blame them. After all, the purpose of Brexit was to get out of that customs union and be free to negotiate terms as they saw fit with other nations. However, as European economic data continues to deteriorate, the pressure on the EU to find a deal will continue to increase. While you cannot rule out a hard Brexit, I continue to believe that some type of fudge will be agreed before this is over. Yesterday the pound suffered greatly, falling below 1.22 for a bit before closing lower by 0.6%. This morning, amid a broadly weaker dollar environment, the pound is a laggard, but still marginally higher vs. the dollar, up 0.1% as I type.

The rest of the FX market was singularly unimpressive overnight, with no currency moving even 0.5% as traders everywhere await the release of the FOMC Minutes this afternoon. Ahead of the Minutes, we only see the JOLTS jobs report (exp 7.25M) which rarely matters to markets. Yesterday’s PPI data was surprisingly soft, falling -0.3% and now has some analysts reconsidering their inflation forecasts for tomorrow. Of course, quiescent inflation plays into the hands of those FOMC members who want to cut rates further. At this point, the softer dollar seems to be more of a reaction to yesterday’s strength than anything else. I expect limited movement ahead of the Minutes, and quite frankly, limited afterwards as well. Tomorrow’s CPI feels like the next big catalyst we will see.

Good luck
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The UK Wants to Shun

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This morning as part of his plan
For Brexit, the PM began
A series of talks,
Before Britain walks,
With Angela as middleman

Alas, when the phone call was done
The odds of a deal approached none
The EU made clear
The (Northern) Irish adhere
To rules the UK wants to shun

The pound is suffering this morning, down 0.5%, after news that a phone call between Boris and Angela resulted in Johnson explaining that a Brexit deal is “essentially impossible” at the current time. If you recall, Boris’s plan was for Northern Ireland to adhere to EU rules on manufactured goods and agricultural products while customs activities would take place a number of miles from the actual border. Finally, Northern Ireland would be allowed to vote every four years to determine if they were happy with that situation. The EU view is that Northern Ireland must remain a part of the customs union in perpetuity, something that would essentially split them from the rest of the UK. It is no surprise that both Boris and Northern Ireland rejected that outcome, and so the Johnson government has increased preparations for a hard Brexit.

There are two interesting tidbits ongoing as well, both of which bode ill for a deal. First is that Irish Taoiseach Leo Varadkar is terrified that he and his nation will be blamed if no deal is reached. And when I say terrified, it means that he is afraid that a no-deal Brexit will result in a significant (~5%) hit to Ireland’s economy and that he will be tossed from office because of that. Remember, every politician’s number one priority during any situation is to be reelected, hence his terror. His response has to increase the rhetoric about how Boris is the problem, further poisoning the well. The second interesting thing is that a survey in the EU by Kantar (a European polling company) showed that between 47% and 66% of citizens in six EU nations (France, Germany, the Netherlands, Ireland, Spain and Poland) believe the EU should not extend the Brexit deadline, with a solid majority in all nations except the Netherlands. Perhaps Boris will get his wish that Europe won’t offer an extension or agree to one if asked. It appears that this saga is reaching its denouement. And despite all of this, I continue to see a strong possibility that the EU blinks as they figure out Boris is serious. My impression is that Merkel and the EU continue to believe that the UK will come begging, hat in hand, for another extension and that a new vote will lead to the end of this process with the UK revoking Article 50. And so they continue to believe they are dealing from a position of strength. We shall see.

Of course, the reason we care so much about this is not just for the impact on the British pound, but actually the impact on the global economy. Consider that the global economy has been slowing steadily for the past eighteen months under pressure from the ongoing trade war between the US and China and the uncertainty that has engendered. If the estimates of the economic impact of a hard Brexit are even halfway correct, we are looking at a sharp decline in economic activity in the UK, Ireland, Germany, France and the Netherlands, ranging between 0.5% and 5.0%. I assure you that will not help the global growth situation. It will also result in immediate additional policy ease by the world’s central banks, notably the Fed. The impact on equity markets will be significant, bond markets will rally sharply as will haven currencies. In other words, it could easily be the catalyst required to bring on that recession on the horizon.

Beyond Brexit, the other big story overnight was on trade as the US put 28 Chinese firms on an export blacklist under the guise of those companies helping in repression of Muslim minorities in northwest China. Not surprisingly, the Chinese were not amused and ‘instructed’ the US to correct its mistake. They also told the world to “stay tuned” for any retaliation that will be forthcoming. Fortunately, this has not changed the plans for the trade talks to be held on Thursday and Friday in Washington with Vice-premier Liu He, at least not yet. But that remains a huge concern, that He will not make the trip and that the trade impasse will harden. At this point it has become pretty clear that a big trade deal is not in the offing. The Chinese appear to be betting that President Trump will lose the election and so are waiting him out. However, this is the one area where the President truly has bipartisan support so it is not clear to me that a President Warren, Biden or Sanders would be any more inclined to come to an agreement that didn’t meet hurdles regarding IP theft and state subsidies.

The combination of these two events has served to undermine equity markets in Europe with virtually every major index having fallen by more than 1% this morning. While Asian equity markets performed well (Nikkei +1.0%, KOSPI +1.2%, Shanghai +0.25%) that was before the Boris-Angela call. US futures have turned lower in the past hour with all three exchanges now pointing to 0.5% declines on the opening. Meanwhile, Treasury yields continue to fall with the 10-year at 1.52%, down 4bps and Bunds are following with yields there down 1.5bps.
As to the dollar, it is no surprise the yen (+0.4%) and Swiss franc (+0.35%) have rallied, but a bit more surprising that aside from the pound, most other G10 currencies are firmer. That said, the movement has not been that large and if we see a true risk-off session in the US, I would expect the dollar to strengthen. In the EMG space, ZAR is the biggest loser today, falling 0.65%, after Renaissance Capital put out a report that the country’s debt would be downgraded to junk status next month. Given their recent track record, correctly calling 8 of the past 9 ratings moves, it is being given some credence. After that, RUB has fallen 0.5% on the back or weaker oil prices, which are down 1.3% this morning and more than 11% from before the attack on the Saudi oil facility in the middle of September.

As to data today, NFIB was already released at a slightly weaker than expected 101.8. While that remains at the high end of its historic readings, it is clear that this series has rolled over and is heading lower. We also get PPI (exp 1.8%, 2.3% ex food & energy) at 8:30 but most folks ignore that and are looking for CPI on Thursday. Chairman Powell speaks again today at 2:30 this afternoon, so all eyes will be focused on Denver to see how he responds to the most recent gyrations in the big stories.

Overall, it feels like a day of uncertainty and risk reduction. Look for further yen and Swiss franc strength as well as for the dollar to regain its footing against the rest of its counterparts.

Good luck
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