Dollar Firm, Sterling Pounded as Risks of Hard Brexit Rise

  • UK Prime Minister Johnson is reportedly seeking an extended suspension of Parliament ahead of the Brexit deadline
  • Italy appears to be close to forming a government
  • There has been a lot of hay made about former NY Fed President Dudley’s op-ed piece yesterday
  • All three measures of the US yield curve remain inverted
  • Israel is expected to keep rates steady at 0.25%; Banco de Mexico releases its quarterly inflation report

The dollar is mostly firmer against the majors as markets face rising risks of hard Brexit.  Euro and Swissie are outperforming, while Kiwi and sterling are underperforming.  EM currencies are mostly weaker.  TRY and MXN are outperforming, while RUB and INR are underperforming.  MSCI Asia Pacific was up 0.1%, with the Nikkei rising 0.1%.  MSCI EM is flat so far today, with the Shanghai Composite falling 0.3%.  Euro Stoxx 600 is down 0.3% near midday, while US futures are pointing to a higher open.  10-year UST yields are down 1 bp at 1.46%, while the 3-month to 10-year spread has inverted 1 bp to stand at -51 bp.  Commodity prices are mostly higher, with Brent oil up 1.2%, copper up 0.7%, and gold flat.

UK Prime Minister Johnson is reportedly seeking an extended suspension of Parliament ahead of the Brexit deadline.  BBC reports that under the plan, Parliament would be suspended from September 12 until the Queen’s Speech October 14.  All legislative matters would be suspended, though it should be noted that Parliament would normally have taken a three-week recess anyway.

The move is a clear signal that Johnson is acting to remove Parliament as a potential obstacle to a hard Brexit.  Under this plan, Parliament would have only a few days before a key EU summit scheduled for October 17-18.  This is not the end of the story, as MPs will not take this lying down.  Elsewhere, the UK is sending its top Brexit negotiator David Frost to Brussels today for more talks.

Sterling has been rocked by the rising risks of hard Brexit, trading at its lowest level since August 22.  A break below $1.2130 is needed to set up a test of the August 12 low near $1.2015.

Elsewhere, Italy appears to be close to forming a government.  Reports suggest the Democratic Party will accept Conte as Prime Minister as long as it gets to choose his Deputy.  Five Star’s Di Maio wants that spot but we expect a lot of horse trading will be seen in the coming hours as the two parties wrangle over cabinet positions.  The 2020 budget will remain contentious for any government.  However, avoiding fresh elections should still be seen as a positive development.

There has been a lot of hay made about former NY Fed President Dudley’s op-ed piece yesterday.  He wrote:  “Officials could state explicitly that the central bank won’t bail out an administration that keeps making bad choices on trade policy, making it abundantly clear that Trump will own the consequences of his actions.”  So far, so good.  We have been saying the same thing, that the Fed should not reward bad trade policies with rate cuts.

However, Dudley went too far when he stepped into politics.  To wit: “If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020.”  This goes totally against the long-held conviction that the Fed remain apolitical at all times.  Yet the fact that Dudley felt compelled to write this tells us that these are not what one might call normal times.

The Fed’s Barkin and Daly speak today.  They are the first to speak since Powell’s Jackson Hole speech, though neither are voting FOMC members this year.  Only US data today is weekly mortgage applications.

All three measures of the US yield curve remain inverted.  The latest to do so is the 2- to 10-year curve at -5 bp.  The 1- to 10-year curve inverted back in early August and stands at -27 bp currently.  The 3-month to 10-year curve inverted back in May and stands at -51 bp.  All three are the most inverted for this cycle and point to recession ahead.

Yet the dollar remains bid.  This supports our view that as bad as the risks have gotten in the US, the rest of the world looks even shakier.  Risks of hard Brexit continue to rise, while Italian political drama continues.  EM in particular is vulnerable to the current backdrop of rising trade tensions and slowing global growth.

Bank of Israel is expected to keep rates steady at 0.25%.  CPI rose only 0.5% y/y in July, the lowest since May 2015 and well below the 1-3% target range.  Despite reports of a possible change in the FX intervention program, the shekel remains relatively firm and that will keep the central bank on hold for now.

Banco de Mexico releases its quarterly inflation report.  Minutes will be released tomorrow.  These two accounts should hold some clues to the central bank’s thinking right now.  The peso held up well right after the surprise 25 bp cut on August 15.  However, weakness has picked up in recent days and so it’s not entirely clear if the central bank will roll the dice again and cut 25 bp at the September 26 meeting.