Monday, December 16, 2019

Glad it’s over. Now for the hard part.

Marshall Gittler

FХ Strategist & Financial Commentator

What a week. The Brexit vote was of course the biggest event of the week. It was a smashing victory for PM Boorish Johnson and a crushing defeat for the Labour Party, which lost some seats it had held for over 100 years. GBP soared on expecations that, as Johnson said, they would now “Get Brexit done.”

My view on the pound:  I think it can probably rally further on continued short-covering and optimism. But eventually reality will sink in and people will realize that this is only the end of the beginning for Brexit, not the beginning of the end. That’s intensely GBP-negative.

The big lie here is the idea that with his new majority, Johnson can pass the Withdrawal Agreement, leave the EU on 31 January, and that’s the end of Brexit. Hah! Here’s a photo, courtesy of my former colleagues at Deutsche Bank, of the recently concluded EU-Canada trade agreement. You can read its 30 chapters and 30 annexes here, or if you want to download all 1,598 pages as one PDF for easier perusing on the train home, try here.

Negotiations for this agreement were first announced in May 2009 and concluded five years later in August 2014. The European Parliament finally agreed to it in February 2017. So eight years from start to (almost) finish – the agreement still had to be ratified by national legislatures after that. And now Britain has a year to negotiate a similar agreement with the EU – plus every other country on earth.

NBHM Weekly Analysis

The fact is, it’s going to be extremely hard to “get Brexit done.” And even if they do, the form of Brexit that they “get done” is hardly decided yet. The hard work is just beginning, and that spells trouble for the pound. See this Bloomberg story:  Getting Brexit Done? Boris Johnson Faces a Bigger Battle in 2020 Or this Guardian story:  This is a Brexit election. But Boris Johnson will not get Brexit done

Furthermore, I hate to bring this up but what if Parliament doesn’t actually pass the Withdrawal Agreement? It’s true that all the Conservative Party candidates standing for election promised to vote for it. But I’m not sure all of them have read it yet, or whether they understand the implications. When they do, they may change their minds, because the deal is apparently worse than what PM May negotiated in one way:  it leaves room for trade barriers between Northern Ireland and Great Britian.

I don’t want to get into the details of this, because a) it’s fantastically complicated, b) you’re not interested, and c) I don’t understand it completely anyway. But trade barriers within the UK could be a deal-killer as far as some people are concerned. The Irish Border was always the insoluble problem of Brexit; it turns out the Johnson government finessed it by lying about what they committed themselves to and hiding it from people.

For anyone interested in the details, I recommend this BBC article, which explains the problem: Will Northern Irish ‘exports’ within UK need checks?

On the other hand, there are now more nationalist MPs in Northern Ireland than there are Unionists. Not only is Johnson no longer dependent on Unionist votes for his majority, the Northern Irish bloc in Parliament probably cares more about trade within the Emerald Isle than trade between Northern Ireland and Britain. That may mean the Conservatives will face less trouble from throwing the Unionists under the bus, but more calls for Northern Ireland to leave the UK.

Similarly with Scotland. Indications are that the Scottish National Party (SNP) won 55 of Scotland’s 59 seats. That would be a decisive rejection of the Conservatives, who held 13 seats in Scotland before the election. The SNP campaigned on promises to try to stop Brexit and to demand another referendum on Scottish independence next year (there was one in September 2014 that resulted in a 55-45 “Remain” vote). Johnson has vowed not to allow the referendum however. Will we be talking about “Scexit” in a few months? While leaving the EU, Johnson has to be careful not to disassemble the United Kingdom at the same time. That would also be profoundly negative for GBP.

Finally, there’s the usual questions about the new government’s economic program. They made pledge after pledge during the campaign, most of which involved spending more money. Johnson won the election by promising working class voters in the north of England and Wales that he would deliver Brexit and address regional imbalances. It remains to be seen what he will actually do.

FOMC decision:   as expected

Moving away from Brexit, the FOMC decision was pretty much as expected: no change in rates, no change in the median forecast of rates, and little change in expectations for the economy. The main point of interest was that those FOMC members who had forecast several rate hikes next year threw in the towel and voted largely for no change. The capitulation of the hawks initially sent the dollar down and gold up. 

NBHM Weekly Analysis

Trade:  Trump folds like an umbrella

Finally, Trump appears to have folded like an umbrella in the US-China trade battle. He has agreed to a “Phase One” deal supposedly includes a promise by the Chinese to buy more agricultural products and commitment to “do more to stop intellectual property theft” in return for not raising the tariffs on some $160bn of Chinese goods that was supposed to go into effect on Sunday. They also discussed reducing the existing tariffs. “The terms have been agreed but the legal text has not yet been finalized,” according to Bloomberg. The interesting thing will be how much of this is actually put in writing – there appears to be some debate about that point. And of course we all remember that famous saying, “a verbal contract isn’t worth the paper it’s printed on.”

Nonetheless, even the appearance of a resolution to this phase of the trade war means a “risk on” environment that’s likely to be good for stocks, good for AUD and NZD, and bad for JPY, CHF and gold. As for EUR/USD, the question I have is whether a “risk on” environment means no need for dollars as a safe haven, or does it mean go ahead with carry trades – including EUR/USD carry trades?

It’s curious though that although Trump was tweeting about the UK elections, he was notably silent about this supposed breakthrough in one of his signature battles. Does this mean he recognizes it as a paper victory? Or that there really isn’t anything there? Press reports say an announcement is expected today. Wait for it. If it’s true and they really do sign something, we could have a further “risk-off” move that would be good for AUD/JPY and negative for gold.


Next week: Bank of Japan, Bank of England, preliminary PMIs

The week just ending was full of drama, but the month and year aren’t over yet. In the coming week we have two major central bank meetings – the Bank of Japan and Bank of England – the preliminary purchasing managers’ indices (PMIs), and inflation data from the US, Japan, Britain and Canada. Plus the odd bits and bobs as usual.

In addition, four members of the FOMC, including three voters, will speak, which should give us a better view of this week’s FOMC decision. Although the decision was unanimous, there may be some variation on how people see things working out.

Plus on Wednesday there’s an ECB colloquium held in honour of Benoît Cœuré on “Monetary policy: the challenges ahead,” featuring ECB President Lagarde, former ECB President Draghi, and a host of other luminaries who will no doubt answer the thousand questions and dispel the 10,000 mysteries about ECB monetary policy.

First the central bank meetings.

The Bank of Japan meeting is seen as a “live” meeting. That is, the market puts a 50% chance on a rate cut – significant enough to bet on. The odds have increased noticeably recently.

NBHM Weekly Analysis

The BoJ might be thinking of easing this time, because the economy has weakened noticeably in the wake of the October hike in the consumption tax. At the press conference following the October BoJ meeting, BoJ Gov. Kuroda said consumption hadn’t fallen off sharply as it did after the April 2014 consumption tax hike. But recent data shows differently; the BoJ’s real consumption activity index was down 7.4% mom in October, on par with -8.5% in 2014 and -7.7% in March 2011, when the Fukushima tsunami hit.

The Bloomberg consensus forecast is for Q3 GDP to decline 2.6% qoq SAAR. However looking at the results of the 2014 consumption tax hike, a steeper decline seems eminently possible.

NBHM Weekly Analysis

Furthermore, today’s tankan report was worse than expected. Manufacturers did poorly, with the large manufacturers DI falling to the lowest level in almost seven years and expectations for next quarter down as well. Large non-manufacturers showed some improvement, although this wasn’t shared by small non-manufacturers. All in all it was a disappointing result that points to further weakness in the Japanese economy.

However, there are three good reasons to expect the BoJ not to change policy. First off, domestically they will probably want to see the impact of the ¥26trn economic stimulus package that the government recently unveiled. Moreover the government is currently in the process of determining next year’s initial budget. It would make sense for the BoJ to wait to see how fiscal policy is shaping up before changing monetary policy.

Secondly, the Bank may well believe that the downturn is temporary. At the October meeting, the BoJ maintained its optimistic stance even though it said it expects the output gap to worsen temporarily.

Third, the global situation seems to be turning. The other central banks that have had meetings this month – Reserve Bank of Australia, Bank of Canada and ECB in particular — all made comments to the effect that the risks to the global economy “have become somewhat less pronounced,” as ECB President Lagarde said. With most other central banks in a “wait and see” mode, it would make sense for the BoJ to wait too rather than shoot one of their few remaining bullets at what might in retrospect turn out to have been an inflection point.

NBHM Weekly Analysis

In short, I don’t think that they will cut rates or adjust policy at this meeting. As a result, I think we could see the yen strengthen somewhat afterwards.

The Bank of England Monetary Policy Committee (MPC) meeting on the other hand is seen as having a very low likelihood of any change – only 2%. And frankly, I think once again politics is going to dominate the pound during the week, not monetary policy. People will be watching the new government and assessing the likelihood of passing the Withdrawal Agreement, what the new government’s economic policies will be, what will happen to the Labour Party, etc., etc. I expect another unanimous decision to keep rates steady, perhaps with some comments about the global outlook being mildly better, as we’ve heard from other central banks. I don’t think this meeting will be a big market-mover and I’m not going to waste your time or mine on it today.

Next in importance come the preliminary purchasing managers’ indices (PMIs) on Monday. The PMIs are showing some reason to be optimistic – there are a number crowding in the upper right-hand corner, the “accelerating expansion” corner. On the other hand, Germany remains an outlier.

NBHM Weekly Analysis

The European PMIs are expected to show improvement, the US is forecast to remain the same. Continues the dominant narrative now of the global economy being past the worst, but not exactly roaring ahead. Central banks can remain at “wait and see” without needing further insurance cuts.

The UK manufacturing PMI is also expected to rise but to remain below the “boom or bust” line of 50. But again, no one is likely to care much about UK indicators next week.

Inflation readings from US, Japan, Britain and Canada

On Friday we get the US personal consumption expenditure (PCE) deflators, the Fed’s preferred inflation gauges. They particularly look at the core PCE deflator. Fed Chair Powell referred to these indicators and not the more commonly known consumer price index (CPI) in the introduction to his press conference Wednesday. Unfortunately for him, the yoy rate of change of the core PCE deflator is expected to slow marginally (no forecast available yet for the headline figure). However, it’s not clear that would worry him particularly. “Against the backdrop of a strong economy and supportive monetary policy, we expect inflation will rise to 2 percent,” he said, noting that “The median of participants’ projections rises to 1.9 percent next year and 2 percent in 2021.” Still, this may cause some concern that would be reflected in the fed funds futures. USD negative

Japan’s national CPI is expected to accelerate slightly at the headline level, in line with the Tokyo CPI, but the core-core – ex-fresh foods & energy – is forecast to remain the same. Pretty amazing considering that they raised the consumption tax 2 percentage point the previous month. Wake me up when Japan inflation gets above 1%. JPY neutral

NBHM Weekly Analysis

UK inflation is expected to remain unchanged at the headline level but, like in the US, to slow a bit in the core measure. Again, not that relevant when the nation’s politics are in such upheaval, but worth noting – it corroborates what we’re seeing in other countries too. No inflationary pressures anywhere. GBP negative, if anyone’s watching.

We also get UK employment on Tuesday and retail sales on Thursday, but again, I think it’ll take some time before people go back to watching the indicators that closely.

NBHM Weekly Analysis

Elsewhere, in the US the Empire State manufacturing index comes out on Monday and the Philly Fed index on Thursday. The Job Openings and Labor Turnover Survey (JOLTS) is on Tuesday. We also get the final revision of Q3 GDP on Friday.

And in Europe, the Ifo survey on Wednesday will attract some attention.

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