Hardliners Abhorred

According to sources, it seems
That Minister May and her teams
Have neared the accord
Hardliners abhorred
As they’ll need to give up their dreams

While there is much in store for markets this week from the US, between the midterm elections tomorrow and the FOMC meeting on Thursday, today’s biggest headline is really about the UK and Brexit. Allegedly, albeit with no corroboration from either side, the entire UK will remain in the customs union, not just Northern Ireland, in the immediate aftermath of Brexit as the two sides continue to work out the eventual solution. May’s idea is that she will present this to her cabinet with an ultimatum to approve it and send it to Parliament in order to get the process completed before the end of the year. And while the other 27 members of the EU must also ratify the deal, the current belief is that there will be limited problems doing that. However, this all remains speculation at this point, except for the fact that May and her cabinet have a meeting scheduled for tomorrow where more details should become available.

It cannot be surprising that the pound has rallied on the news, jumping 60 pips on the open although since giving back about half that original gain. The broad consensus in the market is that any deal will result in the pound trading sharply higher, although I am skeptical that it can stay much above 1.35 for any meaningful amount of time. Even if the Brexit monkey climbs off the pound’s back, the market will still have to account for the fact that UK growth is slowing more sharply than its peers and that the pressure for the BOE to raise rates will likely ebb accordingly. But for now it remains speculation as to whether a deal is imminent or not. And as long as that uncertainty remains, the pound will be beholden to the latest story or headline on the subject.

Away from the pound though, the dollar is starting to show some life at this stage of the morning. Friday’s employment report, with NFP printing at 250K and AHE at 3.1%, confirmed that growth in the US continues to outperform virtually every other region in the world, and will have done nothing to dissuade the Fed from continuing its rate hiking strategy. While there is no expectation of any activity by the Fed on Thursday, the market probability for a rate hike in December remains above 80%. As long as US data continues to outpace that of the rest of the world, it seems unlikely that the Fed is going to stop.

Regarding the US midterm elections, clearly there is the potential for a market reaction depending on the results and whether the Republican party maintains its hold on the House of Representatives. If not, a split government (it is assumed that they will retain the Senate) will clearly impede the president’s plans for further economic stimulus programs and reintroduce brinksmanship to things like budget discussions. Net, given the current economic situation, I expect that after a kneejerk response, it is unlikely to have a significant impact for a while. However, it does open the possibility of more inflammatory rhetoric, including the threat of impeachment hearings, which may well detract from the dollar’s performance going forward. As we learned following President Trump’s election, markets pay close attention to significant electoral changes. With this in mind, it is important to remember that many pundits have been forecasting the Democrats will retake the House, so if the Republicans hold on, even with a much smaller majority, that may be an outcome not currently priced into the market. My point is that there is still great uncertainty to the outcome, and it is not entirely clear the FX impact that will result.

Away from those stories, the biggest news we saw was the weaker than expected Caixin PMI data from China. The Services print was 50.8 with the Composite number at just 50.5. The latter was at its weakest in more than two years and is an indication that the trade conflict with the US is continuing to take a toll on the Chinese economy. In addition, there were several articles in the press this weekend explaining that despite President Trump’s tweets last week, the meeting between Xi and Trump is really just going to get the trade negotiations restarted. There is no deal imminent. It should be no surprise that the renminbi has weakened during the session, especially after last week’s remarkable rally. So the 0.3% decline this morning needs to be kept in context, and simply represents a move back toward its previous trend.

Broadly speaking, the dollar is performing well against the EMG bloc today with MXN (-0.4%), INR (-0.9%) and KRW (-0.5%) indicative of the type of market activity ongoing.

Looking ahead to the upcoming data, we see that beyond the Fed and election, there is precious little that we will learn.

Today ISM Non-Manufacturing 59.3
Tuesday JOLT’s Jobs Report 7.1M
Thursday Initial Claims 214K
  FOMC Rate Decision 2.25%
Friday PPI 0.3% (2.5% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
  Michigan Sentiment 98.0
  Wholesale Inventories 0.3%

So between the US elections and PM May’s cabinet meeting with its chance to make real Brexit headway, there is much to look for this week. But the data will not be the story. As to today’s session, APAC equity markets have reversed some of last week’s gains after it became clear that trade situation wasn’t going to improve in the very short term. US equity futures are pointing lower, although Europe is modestly higher. It all strikes me as though traders are biding their time awaiting the big news, which makes sense. Look for a dull session today, but with the chance for some fireworks tomorrow, at least in the pound if something happens in the cabinet meeting.

Good luck
Adf

Real Strides

In Twenty-sixteen when we learned
That Britain, the EU, had spurned
The pound took a fall
While casting a pall
On how future growth might be earned

For nearly two years chaos reigned
While Brexiteers strongly maintained
A deal will be made
With no one betrayed
And there is still much to be gained

Well last night it seems that both sides
Have finally made some real strides
It’s no real surprise
To see the pound rise
As delegates closed the divides

The big story this morning is that there seemed to be real movement in the Brexit negotiations with an agreement “95% complete” according to the UK government. The key was an agreement regarding financial services, obviously an enormous issue for the UK, whereby UK financial firms would still be given access to the EU based on the “equivalence” of regulations. While this is not quite as robust as the current situation, being within the bloc, it is seen as sufficient to allow continued cross border access in both directions. Of course, the Irish border situation remains outstanding, but there is talk that progress has been made there and that the benefit of a finance deal will be sufficient to offset hard-line concerns over Ireland.

The market response was immediate with the pound jumping more than 1.0% when the headlines hit. If a Brexit deal is reached, the pound likely has further to rise as there is no question it has suffered based on the increasing likelihood of a no-deal situation. That said, a full-throated rally seems unlikely. There are still many other issues that are going to weigh on the pound, notably the dollar’s underlying strength as well as UK economic malaise. In fact, data early this morning showed that the UK manufacturing PMI fell much more than expected to a reading of just 51.1, its lowest reading since the month after the Brexit vote. Obviously, this data did not include the positive news from today, but it is indicative of how the UK economy continues to slow along with the rest of the world. If a deal is signed, I expect the pound could rally another few percent, but anything more than 1.35 would seem to be a stretch based on the economic fundamentals.

But the Brexit story set the tone for the FX market as the dollar is softer across the board, in many other cases having fallen by more than 1% as well. For example, the euro has rallied by 0.6% amid general enthusiasm generated by yesterday’s global stock rebound. We have also seen both Aussie (+1.1%) and Kiwi (+1.4%) jump sharply, as commodity prices stabilize and risk appetite improves.

This theme was also made evident by movements in government bonds around the world, where, for example, Treasury yields are 10bps higher over the last two sessions. In addition, EMG currencies, which had a terrible month in October, have shown some life this morning. Today we see the Mexican peso has rallied 0.8%, while South Africa’s rand is up 1.5%. Even the Chinese yuan, which has been closely scrutinized due to its approaching the critical 7.00 level, has rallied today by 0.4%, its largest gain in more than three weeks. In fact, most EMG currencies are higher, with many gaining more than 0.5%. In other words, it has been a broad-based USD decline. After a strong multi-week run in the dollar, it can be no surprise that a correction has occurred.

Turning to the data situation, yesterday’s ADP number was quite strong, 227K, and the Employment Cost Index (ECI) showed that wages are rising at a 3.1% clip Y/Y, the fastest in several years. While yesterday’s Chicago PMI disappointed slightly at 58.4, that remains a very firm reading historically. Looking forward to today’s session, we hear from the BOE, where policy is forecast to be unchanged, and we will get updated economic forecasts. If a Brexit deal is signed, look for the UK to raise rates several more times next year as there should be a positive growth impact. Then from the US we see Initial Claims (exp 213K), Nonfarm Productivity (2.2%), Unit Labor Costs (1.0%) and ISM Manufacturing (59.0). While these will be seen as important, tomorrow’s payroll data is still going to be the focus, especially the Average Hourly Earnings (AHE) number. With the ECI pointing higher, if AHE shows the same thing, watch for more talk of the Fed becoming even more aggressive.

Ultimately, the US data picture continues to point to strength in the US economy, especially relative to what we are seeing throughout the rest of the world. The EU is slowing, the UK is slowing, China is slowing and so are most other places. As long as this remains the situation, it is hard to expect the dollar to retreat in any meaningful way. While no market moves in a straight line, the dollar’s trend remains higher.

Good luck
Adf