Head of FX Strategy
Summary: The Conservatives outperformed most projections and the UK now has a clear path to Brexit under a strong majority government, if not yet a trade deal and other important questions remain. The market is also celebrating US President Trump claiming a Phase One trade deal with China, even if the latter has yet to corroborate his claims.
The UK election results was beyond even most of the more optimistic projections for the Conservatives, who now have a strong mandate to deliver Brexit and to negotiate on behalf of the UK next year on the eventual trade deal. As I wrote in a recent piece, some key issues remain here for sterling that could keep the ceiling rather low after the currency has reacted so far right in line with my rough guesstimate yesterday (1.3500 for GBPUSD and 0.8250 for EURGBP).
US President Trump claimed a phase one trade deal has been agreed in principle with China, which stoked risk sentiment quite sharply yesterday. The chief development here is the immediate removal of the December 15 tariffs, which would have inflicted widespread damage. Supposedly, other tariffs already implemented will also be reduced. We have a few problems with the rest of the situation. Chief among them is that so far, the Chinese side has maintained radio silence on this deal and some suggest that China would like to keep the terms of the deal out of the public eye, although at least one source claims that a Chinese envoy will sign the deal today. Regardless, the $50 billion agreed is a large target if it is annual and only centered on agricultural goods and commodities, as the country’s largest recent commodity purchase total from the US was the $20 billion in 2017. There may be other promises that are beyond what is signed, if anything, in the official deal. Whatever happens, this is likely “peak deal” for the cycle and the question is how much of a further market rally this deal can sustain.
Late yesterday, the New York Fed quietly rolled out a massive addition of $365 billion in various repos to provide liquidity over year-end, not even bothering to place the announcement in the press releases on its home page. This apparently puts to rest the risk of liquidity issues over year-end that were brought to light by the widely discussed Zoltan Pozsar piece, though some would point out that in that piece, his claim was that “real QE”- or buying of coupon treasuries as opposed to T-bills – would be required. In any case, we only have a handful of trading days left for the year and not a jot of concern on any notable risk metric, so time is running out for this concern to rear its head.
Today we are watching the US Retail Sales data for November with interest and yesterday’s weekly US initial jobless claims number set off an alarm bell we though had been recently extinguished – at 252k this was the worst claims number since hurricane-influenced numbers in September 2017. How this data series and the payrolls numbers shape up after the important holiday shopping season will be crucial for whether the US labor market and economy are deteriorating early next year – an outcome this market is in no way priced for.
Chart: GBPUSD
GBPUSD leapt to the 1.3500 area in response to the clearcut Tory majority and sense that the lay of the post-Brexit landscape is beginning to finally clear up, even if uncertainties on the shape of a final trade deal remain. Our guess is that a trade deal on goods won’t be much of a problem, but the tricky bit will be the UK trying to leverage its financial services industry in any meaningful way, which may prove more of a challenge as it will likely have to remain in the EU regulatory orbit for a frictionless trade deal to be accomplished. In any case – this initial reaction round level of 1.3500 is the key first hurdle here, with the USD outlook the other side of the equation as a weaker USD may be needed as much as a stronger sterling to drive further upside. We’re neutral on sterling here and suspect sideways action for some time in broader sterling levels. Any failure below back below the 1.3200 area achieved ahead of the UK election would represent a significant setback for sterling bulls here.
The G-10 rundown
USD – the US dollar is weak as we would have expected on the trade deal announcement and the Fed’s repo announcement also helping the bears at the margin – need for this move to hold in the coming couple of sessions and we have a real breakout.
EUR – New ECB president Lagarde succeeded in avoiding strong first impressions in terms of policy signals, though she did voice support for negative rates. She took a stab at avoiding market labels, claiming that she would neither be dovish or hawkish but owlish (wise) – good luck with that. For now, the euro absorbing strength at the margin on the UK election outcome.
JPY – the least supportive possible backdrop waxed dramatically yen-hostile on an entirely different level on Trump’s touting of a trade deal breakthrough and on the UK election result.
GBP – the “as expected” outcome may mean that there is little additional upside to wring from sterling in isolated terms (think EURGBP more than GBPUSD if the USD is lurching into a weak phase) as important questions remain for sterling as we outline above.
CHF – I continue to struggle with understanding franc drivers here – a burst of EURCHF upside yesterday on the UK election result after seeming to ignore the entire GBP situation for quite some time- but even that already seems to be fading. Pass.
AUD – all developments yesterday Aussie supportive and AUDUSD has finally traded clear of the channel – but not holding particularly well as of this writing – there isn’t much room for backfilling.
CAD – all factors CAD supportive here and USDCAD trying to trade lower, but has a lot of work to do to work clear of the range to 1.3000 after an ice age for volatility.
NZD – more than a bit disappointed that yesterday’s developments didn’t do more to support AUDNZD as NZD might have lower beta to hopes centered on sentiment on the Chinese outlook basing and turning higher. Next week sees Q3 GDP release – as Q4 is almost over – the tardiest of G10 GDP data.
SEK – the SEK getting maximum support on all fronts at the moment and a continuation of the current regime could see EURSEK down toward the next major area into 10.25-20. Until then, important flash Euro Zone PMIs early next week and then the expected rate hike from the Riksbank next Thursday.
NOK – the US-China trade deal news is the most supportive for NOK on the hopes for global outlook and crude oil getting a nice bump as well – EURNOK could easily challenge 10.00 quickly here despite all of the year-end seasonality headwinds, etc, if the positive market mood continues.
Today’s Economic Calendar Highlights (all times GMT)
2024: The wasted year
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
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