Another Bad Day

Consider Prime Minister May
Who’s having another bad day
Her party is seeking
Her ouster ere leaking
Support, and keep Corbyn at bay

The pound is now bearing the brunt
Of pressure as sellers all punt
On Brexit disaster
Occurring much faster
Thus moving back burner to front

While the rest of the world continues to focus on the US-China trade situation, or perhaps more accurately on the volatility of US trade policy, which has certainly increased lately, the UK continues to muddle along on its painfully slow path to a Brexit resolution of some sort. The latest news is that the Tory party is seeking to change their own parliamentary rules so they can bring another vote of no-confidence against PM May as a growing number in the party seek her resignation. Meanwhile, the odds of a deal with the Labour party continue to shrink given May’s unwillingness to accept a permanent membership in a customs union, a key demand for Labour. This is the current backdrop heading into the EU elections next week. The Brexit party, a new concoction of Nigel Farage, is leading the race in the UK according to recent polls, with their platform as, essentially, leave the EU now! And to top it all off, PM May is seeking to bring her much despised Brexit bill back to the floor for its fourth vote in early June. In other words, while it has probably been a month since Brexit was the hot topic, as the cracks begin to show in UK politics, it is coming back to the fore. The upshot is the pound has been under very steady pressure for the past two weeks, having fallen 2.7% during that time (0.2% overnight), and is now at its lowest point since mid-February.

When the delay was agreed by the EU and the UK, pushing the new date to October 31, the market basically assumed that either Labour would come on-board and a deal agreed, or that a second referendum would be held which is widely expected to point to Remain. (Of course, that was widely expected in the first referendum as well!) However, given that politics is such a messy endeavor, there is no clarity on the outcome. I think what we are observing is the market pricing in much higher odds of a hard Brexit, which remains the law of the land given there are no other alternatives at this time. Virtually every pundit believes that some deal will be struck preventing that outcome, but it is becoming increasingly clear that the FX market, at least, is far less certain of that outcome. For the FX market punditry, this has created a situation where not only trade politics are clouding the view, but local UK politics are doing the same.

Speaking of trade politics, while there is continued bluster on both sides of the US-China spat, the lines of communication clearly remain open as Treasury Secretary Mnuchin seems likely to head back to Beijing again soon for further discussions. At the same time, President Trump has delayed the decision on imposing 25% tariffs on imported autos from Europe and Japan while negotiations there continue, thus helping kindle a rebound in yesterday’s equity markets. As to the FX impact on this news, it was ever so mildly euro positive, with the single currency rebounding a total of 0.2% from its lows before the announcement. Of course, part of the euro’s rally could be pinned on the much weaker than expected US Retail Sales and IP data released yesterday, but given the modesty of movement, it really doesn’t matter the driver.

Stepping back a bit, the dollar’s longer-term trend remains higher. Versus the euro, it remains 5% higher than May 2018, while the broader based Dollar Index (DXY) has rallied 3.5% in that period. And the thing is, despite yesterday’s US data, the US situation appears to be far more supportive of growth than the situation virtually everywhere else in the world. Global activity measures continue to point to a slowing trend which is merely being exacerbated by the trade problems.

Turning to market specifics, Aussie is a touch lower this morning after weaker than expected employment data has helped cement the market’s view that the RBA is going to cut rates at least once this year with a decent probability of two cuts before December. While thus far Governor Lowe has been reluctant to lean in that direction, the collapse in housing prices is clearly starting to weigh elsewhere Down Under. I think Aussie has further to decline.

However, away from that news, there has been much less of interest to drive markets, and so, not surprisingly, markets remain extremely quiet. Something that gets a great deal of press lately has been the decline in volatility and how selling vol has turned into a new favorite trade. (As a career options trader, I would caution against selling when levels have reached a nadir like this. It is not that they can’t decline further, clearly they can, but in a reversal, the pain will be excruciating).
As to the data story, aside from the Australian employment situation, there has been nothing of note overnight. This morning brings Initial Claims (exp 220K) and Housing Starts (1.205M) and Building Permits (1.29M) along with Philly Fed (9.0) all at 8:30. I mentioned the weak Retail Sales and IP data above, but we also saw Empire Manufacturing which was shockingly high at 18.5, once again showing that there is no strong trend in the US data. While there are no Fed speakers today, yesterday we heard from Richmond President Barkin and not surprisingly, he said he thought that patience was the right stance for now. There is no doubt they are all singing from the same hymnal.

Arguably, as long as we continue to get mixed data, there is no reason to change the view. With that in mind, it is hard to get excited about the prospects of a large currency move until those views change. So, for the time being, I believe the longer-term trend of dollar strength remains in place, but it will be choppy and slow until further notice.

Good luck
Adf

 

Still Remote

A Eurozone nation of note
Has recently had to demote
Its latest predictions
In most jurisdictions
Since factory growth’s still remote

The FX market has lately taken to focusing on economic data as the big stories we had seen in the past months; Brexit, US-China trade, and central bank activities, have all slipped into the background lately. While they are still critical issues, they just have not garnered the headlines that we got used to in Q1. As such, traders need to look at something and today’s data was German manufacturing PMI, which once again disappointed by printing at just 44.5. While this was indeed higher than last month’s 44.1, it was below the 45.0 expectations and simply reaffirmed the idea that the German economy’s main engine of growth, manufacturing exports, remains under significant pressure. The upshot of this data was a quick decline of 0.35% in the euro which is now back toward the lower end of its 1.1200-1.1350 trading range. So even though Chinese data seems to be a bit better, the impact has yet to be felt in Germany’s export sector.

This follows yesterday’s US Trade data which showed that the deficit fell to -$49.4B, well below the expected -$53.5B. Under the hood this was the result of a larger than expected increase in exports, a sign that the US economy continues to perform well. In fact, Q1 GDP forecasts have been raised slightly, to 2.4%, on the back of the news implying that perhaps things in Q1 were not as bad as many feared.

Following in the data lead we saw UK Retail Sales data this morning and it surprised on the high side, rising 1.1%, well above the expected -0.3% decline. The UK data continues to confound the Chicken Little crowd of economists who expected the UK to sink into the North Sea in the wake of the Brexit vote. And while there remains significant uncertainty as to what will happen there, for now, it seems, the population is simply going about their ordinary business. The benefit of the delay on the Brexit decision is that we don’t have to hear about it every single day, but the detriment remains for UK companies that have been trying to plan for something potentially quite disruptive but with no clarity as to the outcome. Interestingly, the pound slid after the data as well, down 0.25%, but then today’s broader theme is that of a risk-off session.

In fact, looking at the usual risk indicators, we saw weakness in equity markets in Asia (Nikkei -0.85%, Shanghai -0.40%) and early weakness in European markets (FTSE -0.1%) but the German DAX, after an initial decline, has actually rebounded by 0.5%. US futures are pointing lower at this time as well, although the 0.15% decline is hardly indicative of a collapse. At the same time, Treasury yields are slipping with the 10-year down 4bps to 2.56% and both the dollar and the yen are broadly higher. So, risk is definitely on the back foot today. However, taking a step back, the reality is that movement in most markets remains quite subdued.

With that in mind, there is really not much else to discuss. On the data front this morning we see Retail Sales (exp 0.9%, 0.7% -ex autos) and then at 10:00 we get Leading Indicators (0.4%) which will be supported by the ongoing equity market rally. There is one more Fed speaker, Atlanta’s Rafael Bostic, but the message we have heard this week has been consistent; the Fed remains upbeat on the economy, expecting GDP growth on the order of 2.0% as well as limited inflation pressure which leads to the current wait and see stance. There is certainly no indication that this is going to change anytime soon barring some really shocking events.

Elsewhere, the Trump Administration has indicated that the trade deal is getting closer and there is now talk of a signing ceremony sometime in late May, potentially when the President visits Japan to pay his respects to the new emperor there. (Do not forget the idea that the market has fully priced in a successful trade outcome and when it is finally announced, equities will suffer from a ‘sell the news mentality.) With the Easter holidays nearly upon us, trading desks are starting to thin out, however, while liquidity may suffer slightly, the current lack of market catalysts means there is likely little interest in doing much anyway. Overall, today’s dollar strength is likely to have difficulty extending, and if we see equity markets reverse along the lines of the DAX, it would not be surprising to see the dollar give back its early gains. But in the end, another quiet day is looming.

Good luck and good weekend
Adf

Given the Easter holidays and diminished activity, the next poetry will arrive on Tuesday, April 23.

Addiction To Debt

A policy change did beget
In China, addiction to debt
Per last night’s report
Financial support
Continues, the bulls’ views, to whet

The data from China continues to surprise modestly to the upside. Last week, you may recall, the Manufacturing PMI report printed above 50 in a surprising rebound. Last night, Q1 GDP printed at 6.4%, a tick better than expected, and the concurrent data; Fixed Asset Investment (6.3%), IP (8.5%) and Retail Sales (8.7%) all beat expectations as well. In fact, the IP data blew them away as the analyst community was looking for a reading of 5.9%. While there is some possibility that the data is still mildly distorted from the late Lunar New Year holiday, it certainly seems as though the Chinese have managed to prevent any significant further weakness in their economy.

How, you may ask, have they accomplished this feat? Why the way every government does these days. As we also learned last week, debt in China continues to grow rapidly, far more rapidly than the economy, which means that every yuan of debt buys less growth. It should be no surprise that there is diminishing effectiveness in this strategy, but it should also be no surprise that this is likely to be the way forward. In the short run, this process certainly pads the data story, helping to ensure that growth continues. However, there is a clear and measurable negative aspect to this policy.

Exhibit A is real estate. One of the areas seeing the most investment in China continues to be real estate. The problem with expanding real estate debt (it grew 11.6% in Q1 compared to 6.4% growth for GDP) is that real estate investment is not especially productive. For an economy that relies on manufacturing, productivity growth is crucial. The more money invested in real estate, the less available for improved efficiencies in the economy. Longer term this will lead to slower GDP growth in China, just as it has done in all the developed world economies. However, as politics, even in China, is based on the here and now, there is no reason to expect these policies to change. Two years ago, President Xi tried to force a crackdown on excessive debt used to finance the property bubble that had inflated throughout China. However, it is abundantly clear that the priorities have shifted to growth at all costs. At this stage, I expect that we will see consistently better numbers out of China going forward, regardless of any trade resolution. If Xi wants growth, that is what the rest of the world will see, whether it exists or not.

Turning to the FX market, this implies to me that we are about to see CNY start to strengthen further. Last night saw a 0.40% rally taking the dollar down to key support levels between 6.68-6.69. I expect that we are going to see the renminbi start a more protracted move higher and at this point would not be surprised to see the USDCNY end 2019 around 6.30. That is a significant change in my view from earlier this year, but there has also been a significant change in the policy stance in China which cannot be ignored.

Elsewhere, risk overall has been ‘on’ as investors have responded to the better than expected Chinese data, as well as the continued dovishness from the central banking community, and keep buying stocks. If you recall several weeks ago, there was a conundrum as both stocks and bonds were rallying. At the time, the view from most pundits was that the stock market was wrong and that the bond market was presaging a significant slowdown in the economy. In fact, we saw that first yield curve inversion at the time in early March. However, since then, 10-year Treasury yields have backed up by 22bps and now sit above 2.60% for the first time in a month, while stock prices have continued to rally. As such, it appears that the bond market had it wrong, not the stock market. The one caveat is that this stock market rally has been on diminishing volumes which implies that it is not that widely supported. The opposing viewpoints are the bulls believe there is a big catch up rally in the wings as those who have missed out reach peak FOMO, while the bears believe that though the rally has been substantial, it has a very weak underlying basis, and will retreat rapidly.

As to the FX market, yesterday saw dollar strength, which was a bit surprising given the weaker than expected economic data (both IP and Capacity Utilization disappointed) as well as mixed to negative earnings data from the equity market. However, this morning, the dollar has retraced those gains with the pound being the one real outlier, falling slightly amid gains in virtually every other currency, as inflation data from the UK printed softer than expected at 1.9%, thus pushing any concept of tighter policy even further into the future.

On the data front, this morning brings the Trade Balance (exp -$53.3B) and then the Fed’s Beige Book is released this afternoon. We also have two more Fed speakers, Harker and Bullard, but that message remains pretty consistent. No change in policy in the near future and all efforts to determine the best way to push inflation up to the target level. What this means in practice is that there is a vanishingly small probability that US monetary policy will tighten any further in the near future. Of course, neither will policy elsewhere tighten, so I continue to view the dollar’s prospects positively with the clear exception of the CNY as mentioned above.

Good luck
Adf

 

Mario’s Turn

It’s Mario’s turn to explain
Why rates should start rising again
His problem, of course
Is he can’t endorse
A rise if it leads to more pain

Markets have been quiet overnight as traders and investors await the ECB’s policy statement, and then perhaps more importantly, Signor Draghi’s press conference to be held at 8:30 this morning. The word filtering out from the ECB is that the TLTRO discussion has moved beyond the stage of IF they need to be rolled over to the stage of HOW exactly they should construct the process. Yesterday’s OECD downgrade of Eurozone growth is likely the last straw for the more hawkish ECB members, notably Germany, Austria and the Netherlands. This is especially so given the OECD slashed their forecasts for German growth by 0.8%! As it happens, Eurozone GDP data was released this morning, and it did nothing to help the monetary hawks’ cause with Q4’s estimate revised lower to 1.1% Y/Y. While the FX market has shown little overall movement ahead of the ECB meeting, European government bonds have been rallying with Italy, the country likely to take up the largest share of the new TLTRO’s, seeing the biggest gains (yield declines) of all.

Once again, the juxtaposition of the strength of the US economy and the ongoing weakness in the Eurozone continues to argue for further gradual strength in the dollar. That US strength was reaffirmed yesterday by the much higher than expected trade deficit (lots more imports due to strong demand) as well as the ADP Employment report, which not only saw its monthly number meet expectations, but showed a massive revision to the previous month, up to 300K from the initial 213K reported. So, for all the dollar bears out there, please explain the drivers for a weaker dollar. While the Fed has definitely turned far less hawkish, so has every other central bank. FX continues to be a two-sided game with relative changes the key drivers. A more dovish ECB, and that is almost certainly what we are going to see this morning, is more than sufficient to undermine any long-term strength in the euro.

Beyond the ECB meeting, however, the storylines remain largely the same, and there has been little movement in any of the major ones. For example, the Brexit deadline is drawing ever closer without any indication that a solution is at hand. Word from the EU is that they are reluctant to compromise because they don’t believe it will be sufficient to get a deal over the line. As to PM May, she is becoming more explicit with her internal threats that if the euroskeptics don’t support her deal, they will be much less pleased with the ultimate outcome as she presupposes another referendum that will vote to Remain. The pound continues to struggle in the wake of this uncertainty, falling another 0.25% overnight which simply indicates that despite all the talk of the horror of a no-deal Brexit, there is a growing probability it may just turn out that way.

Looking at the US-China trade talks, there has been no word since Sunday night’s WSJ story that said the two sides were moving closer to a deal. The trade data released yesterday morning was certainly significant but is really a reflection of the current global macroeconomic situation, namely that the US economy continues to be the strongest in the world and continues to absorb a significant amount of imports. At the same time, weakness elsewhere has manifested itself in reduced demand for US exports. In addition, there was probably some impact from US importers stuffing the channel ahead of worries over increased tariffs. With that concern now dismissed after the US officially stated there would be no further tariff increases for now, channel stuffing is likely to end, or at least slow significantly. Given the lack of information regarding the status of the trade talks, there is no way to evaluate their progress. The political imperatives on both sides remain strong, but there are some very difficult issues that have yet to be addressed adequately. In the meantime, the reniminbi has been biding its time having stabilized over the past two weeks after a 3.0% rally during the previous three months. That stability was evident overnight as it is essentially unchanged on the day.

Beyond those stories there is precious little to discuss today. There is a bit of US data with Initial Claims (exp 225K) along with Nonfarm Productivity (+1.6%) and Unit Labor Costs (+1.6%) all released this morning. In addition, we hear from Fed governor Brainerd (a known dove) early this afternoon. But those things don’t seem likely to be FX drivers today. Rather, it is all about Signor Draghi and his comments. The one other thing to note is that risk appetite in markets, in general, has been ebbing of late. US Equities have fallen in six of the past eight sessions and futures are pointing lower again. The same has largely been true throughout Europe, where markets are lower this morning by roughly 0.4%. fear is a growing factor in markets overall, and as we all know by now, both the dollar and the yen are the main FX beneficiaries in that scenario. It feels like the dollar has room to edge higher today, unless Draghi is quite hawkish. And that is a low probability outcome!

Good luck
Adf

 

Quite Sublime

The markets are biding their time
Awaiting a new paradigm
On trade and on growth
While hoping that both
Instill attitudes quite sublime

The dollar has rebounded this morning as most of the news from elsewhere in the world continues to point to worsening economic activity. For example, the German ZEW survey printed at -13.4, which while marginally better than the expected -13.6, remains some 35 points below its long-term average of +22. So, while things could always be worse, there is limited indication that the German economy is rebounding from its stagnation in H2 2018. Meanwhile, Italian Industrial Orders fell to -1.8%, well below the +0.5% expectation, and highlighting the overall slowing tenor of growth in the Eurozone. As I have mentioned over the past several days, we continue to hear a stream of ECB members talking about adding stimulus as they slowly recognize that their previous views of growth had been overestimated. With all this in mind, it should be no surprise the euro is lower by 0.25% this morning, giving back all of yesterday’s gains.

At the same time, Swedish inflation data showed a clear decrease in the headline rate, from 2.2%, down to the Riksbank’s 2.0% target. This is a blow to the Riksbank as they had been laying the groundwork to raise rates later this year in an effort to end ZIRP. Alas, slowing growth and inflation have put paid to that idea for now, and the currency suffered accordingly with the krone falling 1.5% on the release, and remaining there since then. Despite very real intentions by European central bankers to normalize policy, all the indications are that the economy there is not yet ready to cooperate by demonstrating solid growth.

The last data point of note overnight was UK employment, where the Unemployment rate remained at a 40 year low of 4.0% and the number of workers grew by 167K, a better than expected outcome. In addition, average earnings continue to climb at a 3.4% pace, which remains the highest pace since 2008. Absent the Brexit debate, and based on previous comments, it is clear that the BOE would feel the need to raise rates in this situation. But the Brexit debate is ongoing and uncertainty reigns which means there will be no rate hikes anytime soon. The latest news is that Honda is closing a factory in Swindon, although they say the driving impulse is not Brexit per se, but weaker overall demand. Nonetheless, the 4500 jobs lost will be a blow to that city and to the UK overall. Meanwhile, the internal politics remain just as jumbled as ever, and the political infighting on both sides of the aisle there may just result in the hard Brexit that nobody seems to want. Basically, every MP is far more concerned about their own political future than about the good of the nation. And that short-sightedness is exactly how mistakes are made. As it happens, the strong UK data has supported the pound relative to other currencies, although it is unchanged vs. the dollar this morning.

Pivoting to the EMG bloc, the dollar is generally, but not universally higher. Part of that is because much of the dollar’s strength has been in the wake of European data well after Asian markets were closed. And part of that is because today’s stories are not really dollar focused, but rather currency specific. Where the dollar has outperformed, the movement has been modest (INR +0.2%, KRW +0.2%, ZAR +0.4%), but it has fallen against others as well (BRL -0.2%, PHP -0.2%). In the end, there is little of note ongoing here.

Turning to the news cycle, US-China trade talks are resuming in Washington this week, but the unbridled optimism that seemed to surround them last week has dissipated somewhat. This can be seen in equity markets which are flat to lower today, with US futures pointing to a -0.2% decline on the opening while European stocks are weaker by between -0.4% and -0.6% at this point in the morning. On top of that, Treasury yields are creeping down, with the 10-year now at 2.66% and 10-year Bunds at 0.10%, as there is the feeling of a modest risk-off sentiment developing.

At this point, the key market drivers seem to be on hold, and until we receive new information, I expect limited activity. So, tomorrow’s FOMC Minutes and Thursday’s ECB Minutes will both be parsed carefully to try to determine the level of concern regarding growth in the US and Europe. And of course, any news on either trade or Brexit will have an impact, although neither seems very likely today. With all that in mind, today is shaping up to be a dull affair in the FX markets, with limited reason for the dollar to extend its early morning gains, nor to give them back. There is no US data and just one speaker, Cleveland’s Loretta Mester, who while generally hawkish has backed off her aggressive stance from late last year. Given that she speaks at 9:00 this morning, it may be the highlight of the session.

Good luck
Adf

 

Great Apprehensions

In England the rate of inflation
Has fallen despite expectation
By Carney and friends
That recent price trends
Would offer rate hike validation

But markets have turned their attentions
To news of two likely extensions
The deadline on trade
And Brexit charade
Have tempered some great apprehensions

Two key data points lead the morning news with UK inflation falling below the BOE’s 2.0% target for the first time since the Brexit vote while Eurozone IP fell far more sharply than expected. Headline CPI in the UK declined to 1.8% while core remained at 1.9%, with both printing lower than market expectations. Given the slowing economic picture in the UK (remember the slowest growth in six years was reported for Q4 and 2018 as a whole), this cannot be that much of a surprise. Except, perhaps, to Governor Carney and his BOE brethren. Carney continues to insist that the BOE may need to raise rates in the event of a hard Brexit given the possibility of an inflation spike. Certainly, there is no indication that is likely at the present time, but I guess anything is possible. Granted he has explained that nothing would be done until the “fog of Brexit” has lifted but given the overall global growth trajectory (lower) and the potential for disruption, it seems far more likely that the next BOE move is down, not up. The pound originally sold off on the news but has since reversed course and is higher by 0.3% as I type. Overriding the data seems to be a growing belief that both sides will blink in the Brexit negotiations resulting in a tentative agreement of a slightly modified deal with a few extra months made available to ratify everything. That’s probably not a bad bet, but it is by no means certain.

On the Continent, the data story was also lackluster, with Eurozone IP falling a much worse than expected -0.9% in December and -4.2% Y/Y. It is abundantly clear that Germany’s problems are not unique and that the probability of a Eurozone recession in 2019 is growing. After all, Italy is already there, and France has seen its survey data plummet in the wake of the ongoing Gilets Jaunes protests. However, despite this data, the euro has held onto yesterday’s modest gains and is little changed on the day. The thing is, I still cannot figure out a scenario where the ECB actually raises rates given the economic situation. Even ECB President Draghi has recognized that the risks are to the downside for the bloc’s economy, and yet he is fiercely holding onto the idea that the next move will be higher rates. It won’t be higher rates. The next move is to roll over the TLTRO’s and interest rates will remain negative for as far as the eye can see. There is a growing belief in the market that because the Fed has halted its policy tightening, the dollar will fall. But since every other central bank is in the same boat, the relative impact still seems to favor the US.

Away from those stories, the market continues to believe that a US-China trade deal is almost done. At least, that’s the way equity markets are trading. President Trump’s comment that he would consider extending the March 1 tariff deadline if there was sufficient progress and it looked like a deal was in the offing certainly helped sentiment. But as with the Brexit issue, where the Irish border situation does not offer a simple compromise, the US requests for ending forced technology transfer and IP theft as well as the reduction of non-tariff barriers strike at the heart of the Chinese economic model and will not be easily overcome. It seems that the most likely outcome will be a delay of some sort and then a deal that will have limited long-term impact but will get played up by both sides as win-win. In the meantime, the PBOC will continue to add stimulus to the economy, as will the fiscal authorities, as they seek to slow the rate of decline. And you can be sure that no matter how the economy actually performs, the GDP data will be firmly above expectations.

And those are the big stories. The dollar has had a mixed performance overnight with two currencies making substantial gains, NZD +1.25% and SEK +0.6%, both of which responded to surprises by their respective central banks. The RBNZ left rates on hold, as universally expected, but instead of offering signs of further rate cuts, simply explained that rates would remain on hold for two years before likely rising. This was taken as hawkish and the currency responded accordingly. Similarly, the Riksbank in Stockholm explained that they still see the need for rates to rise later this year despite the current slowing growth patterns throughout Europe. As I had written yesterday, expectations were growing that they would back away from any policy tightening, so the krone’s rally should be no real surprise. But beyond those two stories, movement has been much less substantial in both the G10 and EMG blocs.

This morning’s data brings CPI (exp 1.5% headline, 2.1% core) which will be closely watched by all markets. Any further weakness will likely see another leg higher in equity markets as it will cement the case for the Fed having reached the end of the tightening cycle. A surprise on the high side ought to have the opposite impact, as concerns the Fed might not yet be done will resurface. There are also three Fed speakers, but for now, that message of Fed on hold seems pretty unanimous across the FOMC.

Absent a surprise, my money is on a directionless day today. The dollar’s recent rally has stalled and without a new catalyst will have a hard time restarting. However, there is no good reason to think things have gotten worse for the buck either.

Good luck
Adf

 

A Few Tweaks

Ms May explained that her Plan B
Was really a wonder, you see
She’d get a few tweaks
And then in ten weeks
The UK would finally be free!

The way I see it, Plan B is essentially a game of chicken. To date, the EU has said that they are firm and will not cede any more ground than that already outlined in the deal on the table. However, with ten weeks to go, the reality that the UK could exit with no deal is starting to hit home. Regardless of what they have said to date, a hard Brexit is going to have real negative impacts on the EU, especially Germany, the Netherlands and France, as they are the biggest trading partners of the UK. So, PM May went back to Parliament and explained that she would go back to the EU and explain that there needed to be some changes or else it was no deal. The first cracks appeared on the EU side with Poland discussing a 5-year transition period as a possibility, although so far, no other EU nation has piped up.

But consider the situation for the ECB. Signor Draghi is desperate to move further down the road of reducing the extraordinary monetary ease that the ECB has implemented. Stopping QE was to be the beginning of the process with the next steps to be slow and steady rate increases. Now, it is already looking like a questionable call, and a hard Brexit will definitely result in even slower Eurozone growth, thus ratcheting up the pressure on Draghi to do something. Remember, this is the man who did ‘whatever it took’ to save the euro during the sovereign debt crisis in 2012. But interest rates are already negative, and they just ended QE last month. Will they really start it up again in a few months’ time? There is significant pressure building on the EU to blink, although whether or not they do is still unclear.

Yesterday I discussed the idea that Parliament would try to take matters into its own hands given its dissatisfaction with PM May’s deal, but that would be an extraordinary outcome, and is in no way certain to be achieved. This morning, the pound has edged higher (just 0.2%) after surprisingly good employment data with the Unemployment Rate falling to 4.0%. Sterling continues to trade well above the lows seen in December though well below most economist estimates of ‘fair value.’ The thing is, given the possibility that there is no Brexit, which would arguably result in a very sharp Sterling rally, as well as the possibility there is a hard Brexit, which would result in a very sharp decline, maybe the pound is in the right place after all. And for hedgers, 50/50 is the best I can offer. If pressed, I would say the odds of no Brexit have increased, but there is still no way to know at this point in time.

Other than this story, however, there is precious little new news of interest to the FX world. The trade situation continues to percolate, as does the US government shutdown, but neither one has seen any change of note overnight. In both cases, there doesn’t appear to be a deal in the near future.

Broadly speaking, risk is off today, with the dollar modestly higher against most counterparts, equity markets softening somewhat along with commodities and Treasury and Bund yields declining slightly. There are still many problems extant in the world, it’s just that none of them are acute right now. However, the odds of another significant disruption appear to be increasing, hence the risk reduction we are witnessing today.

This morning’s data is Existing Home Sales (exp 5.25M), which is unlikely to impact the dollar very much unless it misses by a lot. Otherwise, the market is likely to continue this modest risk aversion unless we hear something about either Trade or the shutdown. In other words, look for a quiet FX session today.

Good luck
Adf