Is anyone truly surprised
That Parliament, once authorized
To find a solution
Found no substitution
For May’s deal that they so despised?
One of the more confusing aspects of recent market activity was the rally in the pound when Parliament wrested control of the Brexit process from PM May. The idea that a group of 650 fractious politicians could possibly agree on a single idea, especially one so fraught with risks and complexities, was always absurd. And so, predictably, yesterday Parliament voted on seven different proposals, each designed to be a path forward, and none of them even came close to achieving a majority of votes. This included a vote to prevent a no-deal Brexit. In the meantime, PM May has now indicated she will resign regardless of the outcome, which, arguably, will only lead to more chaos as a leadership fight will now consume the Tories. In the meantime, there is still only one deal on the table, and it doesn’t appear to have the votes to become law. As such, while I understand that the idea of a hard Brexit is anathema to so many, it cannot be dismissed as a potential outcome. It should not be very surprising that the FX market is taking the idea a bit more seriously this morning, although only a bit, as the pound has fallen a further 0.4%, which makes the move a total of 1.0% lower in the past twenty-four hours.
One way to look at the pound’s value is as a probability weighted price of three potential outcomes; no deal, passing May’s deal and a long delay. Based on my views that spot would trade to 1.20, 1.38 or 1.40 depending on those outcomes, and assigning probabilities of 40%, 20% and 40% to those outcomes, spot is actually right where it belongs near 1.3160. But that leaves room for a lot of movement!
Meanwhile, elsewhere in the FX market, volatility is making a comeback. Between Turkey (-5.0%), Brazil (-3.0%) and Argentina (-3.0%), it seems that traders are beginning to awaken from their month’s long hiatus. Apparently, the monetary policy anesthesia that had been administered by central banks globally is wearing off. As it happens, each of these currencies is dealing with local specifics. For instance, upcoming elections in Turkey have President Erdogan on the defensive as his iron grip on power seems to be rusting and he tries to crack down on speculators in the lira. Meanwhile, recently elected Brazilian president Bolsonaro has seen his honeymoon end quite abruptly with his approval ratings collapsing and concerns over his ability to implement key policies seen as desirable by the markets, notably pension reform. Finally, Argentine president Macri remains under pressure as the slowing global growth picture severely restricts local economic activity although inflation continues to run away to unsustainable levels (4% per month!) and the peso, not surprisingly is suffering.
As to the G10, activity there has been less impressive although the dollar’s tone this morning is one of strength, not weakness. In fact, risk continues to be jettisoned by investors as can be seen by the continuing rally in government bonds (Treasury yields falling to 2.35%, Bund yields to -0.07%, JGB’s to -0.09%) while equity markets were weak in Asia and have gained no traction in Europe. Adding to the impression of risk-off has been the yen’s rally (0.2% overnight, 1.0% in the past week), a reliable indicator of market sentiment.
Turning to the data, yesterday saw the Trade Balance shrink dramatically, to -$51.1B, a much lower deficit than expected, and sufficient to positively impact Q1 GDP measurement by a few tenths of a percent. This morning we see the last reading on Q4 GDP (exp 1.8%) as well as Initial Claims (225K). Given the backward-looking nature of Q4 data, it seems unlikely today’s print will impact markets. One exception to this thought would be a much weaker than expected print, which may convince some investors the global slowdown is more advanced than previously thought with equities selling off accordingly. But a better number is likely to be ignored. We also hear from (count ‘em) six more Fed speakers today (Quarles, Clarida, Bowman, Williams, Bostic and Bullard), but given the consistency of recent comments by others it seems doubtful we will learn anything new. To recap, every FOMC member believes that waiting is the right thing to do now and that they should only respond when the data indicates there is a change, either rising inflation or a significant slowing in the economy. Although the market continues to price rate cuts before the end of the year, as yet, there is no indication that Fed members are close to believing that is necessary.
Ultimately, the same key stories are at the fore in markets. Brexit, as discussed above, slowing global growth and the monetary policy actions being taken to ameliorate that, and the US-China trade talks, which are resuming but have made no new progress. One of the remarkable features of markets lately has been the resilience of equity prices despite a constant drumbeat of bad economic news. Investors have truly placed an enormous amount of faith in central banks (specifically the Fed and ECB) to be able to come to the rescue again and again and again. Thus far, that faith has been rewarded, but keep in mind that the toolkit continues to dwindle, so that level of support is likely to diminish. In the end, I continue to see the dollar as a key beneficiary of the current policy mix, as well as the most likely ones for the near future.