Sterling Firms Ahead of Tory Confidence Vote

  • UK Prime Minster May faces a no confidence motion in her leadership of the Tory party
  • Huawei CFO Meng was released on bail in Canada
  • The meeting yesterday between President Trump and Democratic Congressional leaders Schumer and Pelosi did not go well
  • Considering Macron’s volte-face, we ran updated budget and debt numbers for France and the results aren’t pretty
  • US November CPI will be reported today; Sweden November headline CPI rose 2.0% y/y
  • South Africa November CPI rose 5.2% y/y; India reports November CPI and October IP; Brazil COPOM is expected to keep rates steady at 6.5%

The dollar is mixed against the majors as global markets continue to stabilize.  Sterling and euro are outperforming, while Stockie and Kiwi are underperforming.  EM currencies are mostly firmer.  BRL and MXN are outperforming, while INR and TRY are underperforming.  MSCI Asia Pacific was up 1.6%, with the Nikkei rising 2.2%.  MSCI EM is up 1.1% so far today, with the Shanghai Composite rising 0.3%.  Euro Stoxx 600 is up 0.9% near midday, while US equity futures are pointing to a higher open.  The US 10-year yield is up 1 bp at 2.88%.  Commodity prices are mixed, with Brent oil up 1.7%, copper down 0.4%, and gold flat.

UK Prime Minster May faces a no confidence motion in her leadership of the Tory party after the requisite 48 letters requesting one were received.  It will be held tonight from 6-8 PM London time, with results to be posted at 9 PM.  Whether or not it passes is another matter.  If the motion fails, then May remains leader and will continue to steer her Brexit plan towards a January vote.  If she loses, then there will be another vote next week on who will lead the party next.

We saw a marginal new cycle low for cable today before bouncing.  We see no reason to buy sterling now.  If May survives the leadership challenge, her deal is still doomed to failure and likely leads to a no-deal Brexit.  If she loses the vote in favor of a hard Brexiteer, then May’s plan is all but dead and the chances of a no-deal Brexit rise even further.  A clean break of $1.25 seems inevitable and the next target would be the April 2017 low near $1.2350.

Yet the Tories must be aware that their machinations could eventually bring their own party down.  If developments turn out very negative for the Tories, a no confidence vote could be called by opposition Labour.  If the Tories lose that vote, then other parties would try to form a government.  If that fails, then fresh elections would be held and Labour would likely win.  We think this path would be a disaster, even if Corbyn were to call for a new Brexit referendum.  Corbyn represents what we would call Old Labour, not Blair’s centrist New Labour.

Huawei CFO Meng was released on bail in Canada.  Extradition proceedings will commence but could take weeks or month.  President Trump tantalizingly said that he might intervene in the case to help Meng if it would help facilitate a trade deal with China.  There are signs of thaw, with reports suggesting that China would cut tariffs on US auto imports. 

The meeting yesterday between President Trump and Democratic Congressional leaders Schumer and Pelosi did not go well.  Trump threatened to shut down part of the government if he does not get the funding for his wall.  Schumer and Pelosi reportedly made two offers to Trump. Both would keep funding for border fencing at the current level of $1.375 bln, while Trump has said he wants $5 bln.  A partial shutdown would be seen if funding for some government agencies runs out on December 21.

Markets recognize that shutdowns are largely opportunities for political posturing by all parties.  That said, we have seen before that shutdowns can still impact market sentiment negatively.  Going into thin year-end markets that are already nervous about a multitude of risks, there is a good chance that a shutdown would roil markets more than usual.

Considering Macron’s volte-face, we ran updated budget and debt numbers for France and the results aren’t pretty.  Our sovereign ratings model already showed France’s implied rating falling a notch to AA-/Aa3/AA- back in October.  With updated numbers, we have France falling another notch to A+/A1/A+ so there are clearly downgrade risks building up to actual ratings of AA/Aa2/AA.

Between France, Italy, and Brexit, the euro remains heavy and tested support near $1.13 yesterday.  Clean break below the $1.13 area is needed to set up a test of the November low near $1.1215.  EUR/GBP remains bid and appears likely to break above the August high near .9100.

US November CPI will be reported today.  Headline CPI is expected to ease to 2.2% y/y, but core CPI is expected to rise a tick to 2.2% y/y.  If so, these readings are not going to help get US long end rates up very much.  Yesterday, headline PPI came in as expected at 2.5% y/y, but core was higher than expected at 2.7% y/y.

The US also releases its monthly budget statement for November.  A -$199 bln deficit is expected.  If so, the 12-month total would rise to -$876.7 bln and would be near the cycle high of -$890.2 bln from August.  For now, markets have been overlooking the deteriorating US fiscal situation. We think this will become a serious issue for the dollar in 2019 and 2020.

These two data releases could help US yields to continue edging higher.  WIRP shows odds of December hike back at 71% vs. 76% yesterday.  The yield curve continues to flatten in the 2- to 10-year space.  At 12 bp, this spread is down from 13 bp last week.  However, the 1- to 10-year and 3-month to 10-year spreads have widened from last week to 20 bp and 49 bp, respectively.  Lastly, the implied yield on the January 2020 Fed Funds futures contract has risen to 2.60%, the highest since December 6.

Sweden November headline CPI rose 2.0% y/y, as expected.  CPIF rose 2.1% y/y vs. 2.2% expected, and both readings are down 0.3 percentage points from October.  Sweden’s Riksbank meets next week.  It has signaled an intent to hike rates on either December 20 or February 13.  The data have been coming in largely softer than expected, and inflation has fallen back to the target.  We lean towards a February hike considering the ongoing market turmoil, as the bank may benefit from a little more time before moving on rates.

South Africa November CPI rose 5.2% y/y vs. 5.1% expected.  Retail sales was also reported at 2.2% y/y vs. 1.5% expected and 0.7% in September.  Next SARB meeting is January 17 and it will be a tough call.  Much will depend on how the rand is trading then.  If it remains under pressure, then another 25 bp hike to 7.0% seems likely.

India reports November CPI and October IP.  November WPI will be reported Friday.  Price pressures are easing while growth is slowing.  Next RBI meeting is February 6.  While a lot can happen between now and then, we think the RBI will remain cautious and keep rates steady.  Sentiment regarding India has been dented recently by the resignation of RBI Governor Patel as well as the ruling BJP’s defeat in two state polls.

Brazil COPOM is expected to keep rates steady at 6.5%.  IPCA inflation rose only 4.05% y/y in November, the lowest since May.  Markets are pricing in a dovish stance, with hikes not expected to start until mid-year.  October retail sales will be reported Thursday, which are expected to rise 2.6% y/y vs. 0.1% in September.