Head of FX Strategy, Saxo Bank Group
Summary: The resignation of UK Brexit minister Dominic Raab has weakened sterling this morning as this dramatically escalates the risk of a chaotic situation ahead of the March 29 Brexit deadline.
Note: just before going to press we get the news that Dominic Raab, the UK Brexit minister has resigned – this obviously heavily colours the Brexit discussion of today’s post and dramatically raises the risk of a Prime Minister being ousted or resigning.
The situation with the draft Brexit deal is very fluid at the moment, as UK Prime Minister May has to survive the risk of a party revolt in the very nearest term and even if she does, faces the risk of an inability to ram the deal through parliament if a large contingent of the Tory “ERG” rebels vote against. The Northern Irish DUP party has already made clear that it feels betrayed and will not vote in favour.
The deal itself does offer the UK essentially what it wanted: a customs union deal with no freedom of movement for immigrants, but the Tory hardliners see the deal as a loss of UK sovereignty because they have lost a vote in the EU and not gained enough elsewhere.
The EU has now gone as far as setting the date for a dedicated Brexit summit for November 25 to formalise the deal, which will then require a parliamentary vote some time in December, but the question is whether the deal is dead on arrival at that vote.
The Labour gambit is to hope that the Tories self-destruct and they can swoop in and take power in an election and perhaps call a second referendum (I don’t get this – many Brexit voters are traditional Labour voters). Corbyn has offered no credible alternative Brexit vision and looks like a pure opportunist here. It’s all a mess and we have to boil it down to roughly three potential paths from here:
• The May miracle: Theresa May survives the confidence vote and engineers a miracle, perhaps ramming through a key few changes to the deal at the Brexit summit on the 25th to keep the language sufficiently vague on future negotiations to keep most of her party on board, meaning only a few Labour Leave votes are needed to deliver the Brexit under this deal. The threat of chaos could move the EU on key points if it is clear that the deal won’t pass as currently written.
• May survives, but the deal doesn’t: In this scenario, the Tories fail to mount a challenge to May’s leadership and the Brexit summit moves forward, but the eventually deal fails a parliamentary vote. This creates an ugly situation as time is running short into March 29, and might require an emergency extension of the exit date to avoid the embarrassing spectre of customs inspections and goods (think especially food and medicine) shortages in the UK.
• May is ousted or May resigns: this would throw the situation immediately into chaos, with snap elections likely on the menu and the status of the entire Brexit deal thrown into doubt – this is the most immediately sterling negative (as the question arises – is this a "either no-deal exit or Corbyn government”.
And one word of warning on sterling upside potential – if we do end up with the prospect of a Corbyn government, this could quickly curtail sterling upside potential even if a path reemerges of avoiding Brexit (can’t see how this is possible) on the concern that the reddest government since the pre-Thatcher era would prove an economic disaster.
Elsewhere, we have a rather weak US dollar on our hands as Fed rate hike expectations have been lowered a few notches, at least in part on yesterday’s tepid US CPI report (and the idea that lower oil prices will feed slower inflation in coming months) and on a Powell speech yesterday at the Dallas Fed. Some saw Powell’s speech as a change of heart as he enumerated a number of risks from here, but his description of the current economy and financial conditions suggest still strong optimism and satisfaction with the Fed’s current policy as he said that balance sheet reduction is going “very well”.
AUDCAD has seen a remarkable run from near 0.9100 to 0.9600+, in part on an unwind of crowded AUD speculative shorts as the market hopes we are headed toward a US-China trade deal, but also on the ugly sell-off in oil prices that has weight on CAD in the crosses. The bounce looks justified, but I would suggest it is getting overdone unless we see a more profound improvement in the US-China relationship than I am anticipating in the wake of the Xi-Trump meeting at the G20 in a couple of weeks. For now, we’ll watch for signs of mean reversion in this pair, something that it has a history of doing.
USD – US dollar upside pushed back on the unwind in Fed expectations of the last couple of sessions – but not yet convinced that there are legs on this move.
EUR – yes, EURUSD has squeezed back above the clear 1.1300 level that was the former support, but the pair is still in a descending channel and the bear doesn’t look fully challenged unless we pull all the way back above 1.1500. Any ugly Brexit chaos scenario could well rub off on the euro to a degree as well – and we still have the Italian budget sword of Damocles hanging over the EU.
JPY – USDJPY still within the range – we will likely need the market to revert back to pricing more Fed rate hikes to get any liftoff potential above the key 114.50 level. The chart is boring unless we challenge below 112.00 again.
GBP – sterling weakening as the resistance to the current deal is quite clear from Tory hard-liners and the DUP. Sterling will have a hard time putting in a convincing rally in the near term if it is feared that the choice is the Scylla and Charybdis of “no-deal Brexit” vs. Corbyn government.
AUD – the solid jobs report overnight adding to the AUD squeeze – this move looks very mature in some of the crosses, but there could yet be more upside short term if Trump and Xi manage to chum it up in Buenos Aires at the G20. Further out, this won’t stop the ugly unwind in the Australia housing market.
CAD – USDCAD trying to maintain altitude for a go at the sub-1.3400 highs for the cycle, but the volatility of the US-CA rate spread has been uninspiring.
NZD – kiwi relative strength versus the AUD may have been ended by this latest jobs report – certainly yesterday’s lows near the huge AUDNZD trendline are the line in the sand for the bullish hopefuls.
SEK – the krona so far surviving the slightly weaker CPI print – a cut well back below 10.25 could yet regnite hopes for a follow through lower into 10.10-10.00
NOK – can EURNOK rally hold given Brexit situation and now that oil prices may consolidate?
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