Sterling Pounded as Risks of No-Deal Brexit Rise

  • UK Prime Minister May is facing a wave of resignations; the odds of a no-deal Brexit have risen significantly
  • UK reported weak retail sales in October
  • The European Commission (EC) must now decide how to deal with Italy’s defiance
  • During the North American session, US October retail sales will be reported
  • Australia reported strong October jobs data
  • Indonesia and Philippines hiked 25 bp; Mexico expected to follow suit and hike 25 bp

The dollar is mixed against the majors as risks of a no-deal Brexit have risen significantly.  The Antipodeans are outperforming, while sterling and euro are underperforming.  EM currencies are mostly firmer.  TRY and IDR are outperforming, while RON and THB are underperforming.  MSCI Asia Pacific is up 0.8%, with the Nikkei falling 0.2%.  MSCI EM is up 1% so far today, with the Shanghai Composite rising 1.4%.  Euro Stoxx 600 is down 0.4% in morning trading, while US futures are pointing to a higher open.  The US 10-year yield is down 2 bp at 3.10%.  Commodity prices are mostly higher, with Brent oil up 0.4%, copper up 1.4%, and gold flat.

UK Prime Minister May is facing a wave of resignations in protest of the draft Brexit bill.  The meeting was reportedly contentious, with many cabinet members quitting in protest.  The key resignation came from Brexit Secretary Dominic Raab, but others include Esther McVey, Shailesh Vara, and Sueela Braverman.  The Brexit draft must now pass a full vote in the House of Commons.  Many in her own Tory party will oppose it, whilst opposition Labor leader Jeremy Corbyn urged May to withdraw her “half-baked” deal.  There is talk of a no confidence vote in parliament.

As we’ve been warning, the odds of a no-deal Brexit have risen significantly.  Anything that May and the EU agree to is unlikely to pass muster domestically.  With no deal, The UK would be ejected from the EU with no transition period, making things even more disruptive.  Sterling is down big on these developments and is on track to test the October low near $1.27 and the August low near $1.2660.  Longer-term charts point to an eventual test of the October 2016 low near $1.1840.

UK reported weak retail sales in October.  Headline sale fell -0.5% m/m vs. an expected gain of 0.2%.  This pushed the y/y rate down to 2.2% from a revised 3.3% (was 3.0%) in September.  Recall that yesterday’s CPI readings were lower than expected.  Recent developments have led the markets to push back expectations of BOE tightening slightly.  Short sterling implied yields are now pricing in the next hike by June 2019 and the one after that in June 2020.  Previously, they were seen coming in March 2019 and March 2020.

The European Commission (EC) must now decide how to deal with Italy’s defiance.  It will likely issue a statement that the budget has breached EU fiscal rules on November 21. Reports suggests the EC will publish a report on Italy’s debt, which in turn will likely trigger an “excessive debt procedure.”  This wouldn’t start until January, after which Italy will be given 3-6 months to bring its deficit down to an acceptable level.  If Italy does not, it will face fines up to 0.2% of GDP.

The euro remains heavy and is likely to soon test this month’s low near $1.1215.  As we’ve noted, $1.1185 is a key level representing the 62% retracement objective of the big January 2017-February 2018 low.  Break below that would set up a test of the January 2017 low near $1.0340.

During the North American session, US October retail sales will be reported.  Both headline and ex-autos are seen rising 0.5% m/m, while the so-called “control group” used for GDP calculations is seen rising 0.4%.  Given strong auto sales and robust wage gains reported for last month, here too there are upside risks to the numbers.  With a strong start seen so far in Q4, the Atlanta Fed’s GDPNow model is tracking 2.9% SAAR growth while the NY Fed’s Nowcast model is tracking at 2.7% SAAR.

The Fed’s Quarles, Powell, Bostic, and Kashkari speak today.  Yesterday’s CPI data was pretty much as expected but the recent data should keep the Fed feeling confident in its tightening path.  Powell yesterday said the US economy remains strong but noted that there are potential risks from slowing demand abroad, fading fiscal stimulus, and the lagged effect of the Fed’s past hikes.

Australia reported strong October jobs data.  Employment rose 32.8k vs. 20k expected, keeping the unemployment rate steady at 5.0%.  The mix was favorable, as 42.3k full-time jobs were partially offset by -9.5k part-time ones.  AUD tested this month’s high near .7300 but so far has been unable to break above it.

Bank Indonesia delivered a hawkish surprise and hiked rates 25 bp to 6.0%.  Most saw no change.  CPI rose 3.2% y/y in October, below the 3.5% target but within the 2.5-4.5% target range.  Governor Warjiyo noted that the hike was part of its efforts to lower the current account gap and to boost the attractiveness of Indonesian financial assets.

Bangko Sentral Ng Pilipinas hiked rates 25 bp to 4.75%, as expected.  Many saw no change.  CPI rose 6.7% y/y in October, well above the 2-4% target range.  The bank noted that the domestic economy remains strong enough to allow for tightening to rein in inflation expectations and prevent further second round effects.

Banco de Mexico is expected to hike rates 25 bp to 8%.  The peso has come under renewed pressure from political risk even as inflation edges higher.  AMLO has walked back his Senate ally’s plan to eliminate some banking fees but it’s clear that markets had gotten too sanguine about political and policy risk in Mexico.  USD/MXN is on track to test the June high near 20.96.