Brexit Optimism Underpins Sterling

  • The US dollar is mostly firmer, while global equities are softer and bonds little changed
  • Disappointing data from Australia and New Zealand has seen the Antipodean currencies move lower
  • Japan reported that July retail sales rose 0.1% after the heady 1.4% rise in June
  • In addition to NAFTA 2.0 talks with Canada, the North American session also features potentially market-moving data
  • Argentine peso losses are accelerating; Turkish lira remains under pressure
  • Brazil reports July central government budget data and IGP-M wholesale inflation; South Africa July PPI rose 6.1% y/y

The dollar is mostly firmer against the majors.  The Scandies are outperforming, while the dollar bloc is underperforming.  EM currencies are broadly weaker.  KRW and PHP are outperforming, while TRY and ZAR are underperforming.  MSCI Asia Pacific was down 0.2%, with the Nikkei rising 0.1%.  MSCI EM is down 0.4% so far today, with the Shanghai Composite falling 1.1%.  Euro Stoxx 600 is down 0.5% near midday, while US futures are pointing to a lower open.  The 10-year US yield is down 1 bp at 2.88%.  Commodity prices are mixed, with Brent oil up 0.4%, copper down 1.1%, and gold down 0.3%.

The US dollar is mostly firmer, while global equities are softer and bonds little changed.  The Turkish lira and South African rand remain under pressure.  However, there does not appear to be an overall theme in today’s markets.

Disappointing data from Australia and New Zealand has seen the Antipodean currencies move lower.  New Zealand’s business confidence fell to a ten-year low, and this sent the Kiwi tumbling.  Its nearly 0.9% fall leads the majors.  It is followed by the Australian’s dollar’s 0.25% loss in the wake of building approvals (-5.2% vs. the median forecast of -2.0%) and capex (-2.5% vs. the median forecast of a 0.6% increase) misses.  The Aussie held yesterday’s low near $0.7275.  Last week’s low was near $0.7240.

Japan reported that July retail sales rose 0.1% after the heady 1.4% rise in June.  The y/y rate of 1.5% was a bit better than expected.  The Nikkei managed to eke out a minor gain to extend its advancing streak to eight sessions, though it continues to be frustrated near 23000.  Most markets in the region fell, including a 1.15% drop in Shanghai (its third consecutive fall) and the MSCI Asia Pacific Index snapped a four-day advance with a 0.25% loss and an outside down session and a potential key reversal.  That said, the pullback stopped just shy of closing the gap from Tuesday’s higher opening.   We note that foreign investors continued to buy Korean and Taiwanese shares.

The dollar’s momentum carried it to nearly JPY111.85 yesterday has faded, and the dollar is consolidating in the upper end of yesterday’s range.  In the bigger picture, the dollar continues to toy with the weekly downtrend line from 2015.  It had been violated last month when the greenback was lifted to a high near JPY113.20 before pulling back.  Depending exactly how the trendline is drawn, it appears to come in around JPY111.60.  The dollar found support near CNY6.80 in recent sessions and recovered to CNY6.84, new highs for the week.

The euro is consolidating within the two-day range of $1.1650 and $1.1735.  There are no significant nearby options expiring today but tomorrow that there is a $1.17 strike (1.3 bln euros) and a $1.1725 strike (1.5 bln euros).  The main economic data has come in the form of Spanish and Germany preliminary August inflation reports.  Price pressures appear to have eased.  In Spain, the harmonized measure slipped to 2.2% y/y from 2.3%.  In Germany, several large states showed a small easing of inflation.  The national figure due out shortly could show slippage to 2.0% y/y from 2.1%.

European shares are trading softer.  The Dow Jones Stoxx 600 is off a little more than 0.5% after advancing 0.3% yesterday.  All the major sectors are lower, though real estate and telecoms are taking the biggest hit (off ~2%).  With today’s loss, the benchmark is up 0.25% for the week but is off 1.8% on the month.  The German DAX is off 1% today, the most among the major markets.  The DAX is off nearly 3% this month.  If sustained, it would be the biggest monthly loss since February.

Sterling is consolidating yesterday’s sharp gains after yesterday’s sharp advance.  For the first time in months, and just as UK Prime Minister May suggested that leaving the EU without an agreement is “not the end of the world,” optimism helped sterling rally 1.2% yesterday.  This was the biggest gain in seven months and is taking sterling to new highs here in August.  The glass which has been seen as half empty is now seen as half full.  Both UK Brexit Secretary Raab and the EC’s head negotiator Barnier were not talking about the risks of no deal.  To the contrary, with negotiations to resume Friday, Raab suggested that a deal was within reach.  Barnier was reassuring.  The EU, he acknowledged, wants to keep the UK ties as close as possible and is willing to negotiate a unique relationship.

Sterling has appreciated almost four cents since the mid-August low near $1.2660.  Also lending sterling support has been a backing up of UK interest rates.  It seems that the entire 2- to 30-year yield curve increased by around 20-25 bp since the middle of the month. The 10-year breakeven is essentially unchanged over this period, suggesting that the rise in nominal yields reflects an increase in real rates.  Sterling’s gains are likely to prove to be short-covering.  The net short sterling position, for example, in the futures market was the largest since May 2017.  The gross short position has jumped from around 80k contracts at the beginning of the month to over 140k as of August 21.  The next technical targets are around $1.3070 and then $1.3130.

In addition to NAFTA 2.0 talks with Canada, which are said to be going well, the North American session also features potentially market-moving data.  Canada reports Q2 GDP.  It is expected to a have accelerated to 3.1% from 1.3% in Q1 (annualized).  However, it reflects earlier momentum, and the monthly read for June may show a 0.1% gain following May’s 0.5% expansion.  Recent official comments have reinforced market expectations for another rate hike in October.  The US dollar continues to trade within Tuesday’s range of roughly CAD1.2890 and CAD1.2990.

The US reports July personal income and consumption data.  We suspect both have downside risks to the market’s median forecast that each rose 0.4%.  We are concerned that weakness in farm income will weigh on personal income, while 3.8% consumption pace in Q2 is unlikely to have been sustained.  Personal consumption expenditures averaged a monthly gain of 0.4% in Q2.   Weekly initial jobless claims are expected to have remained in their trough.

Argentine peso losses are accelerating after the government asked the IMF for early disbursement of the next aid tranche.  The request suggests policymakers still don’t have a handle on things.  Foreign reserves fell to $54.3 bln yesterday, the lowest level since the initial $15 bln IMF tranche boosted reserves from $48.5 bln to $63.3 bln back in June.  That means Argentina has already bled $9 bln of those funds even as the peso has weakened another 18% since the deal was approved June 20, with nearly 8% lost just yesterday!

If Argentina can’t stabilize things with orthodox policies and IMF backing, how can Turkey hope to following unorthodox policies?  Short answer:  It can’t.  USD/TRY is trading at its highest level since August 14 and is well on its way towards testing the all-time high near 7.2360 from August 13.  The lira has lost nearly 10% just this week after a period of calm during the previous week’s holiday, as markets await a stronger policy response.  At this pace, we think the central bank will be forced to hike rates before the September 13 meeting.

Brazil reports July central government budget data and IGP-M wholesale inflation.  Q2 GDP and consolidated budget data will be reported Friday, with growth expected at 1.1% y/y vs. 1.2% in Q1.  PPI and IGP-M measures of producer inflation are accelerating.  Next COPOM meeting is September 19, and markets are split.  The analysts see steady rates at 6.5%, while the CDI market is pricing in the start of the tightening cycle then with a 25 bp hike to 6.75%.  We lean towards a hike then, especially if BRL losses continue.

South Africa July PPI rose 6.1% y/y vs. 6.0% expected and 5.9% in June.  The economy remains sluggish, but price pressures are rising as CPI inflation was 5.1% y/y in July.  This was the highest since September and is nearing the top of the 3-6% target range.  Next policy meeting is September 20.  While no change is expected, much will depend on external conditions and the rand.  At the very least, we expect a hawkish hold.