Head of FX Strategy
Summary: The UK Parliament cannot avoid a vote today on the Brexit deal, but additional votes are needed before we know the full outlines of the Brexit path from and whether it can be achieved before the October 31 deadline. A snap election is likely coming for the UK regardless. Beyond the Brexit focus, rising bond yields are our chief focus as yield curve steepening seem behind JPY and USD weakness.
Brexit really is finally reaching the crunch phase, as the UK Parliament will have to vote on Boris Johnson’s deal today after avoiding two votes in the last two parliamentary sessions. The vote today will be on the deal legislation itself rather than Monday’s intended “meaningful vote” indicating voting intentions rather than voting on whether to actually pass the deal. But that’s not the end of the story, because a subsequent vote is required to approve a highly compressed timeline for getting the deal through, a process that normally takes weeks, but would have to be accomplished in a mere few days to get the deal delivered before the October 31 deadline. That timeline vote could yet fail, opening up for amendments on anything from the UK staying in the EU customs to the need for a second referendum. In that case, while the deal will eventually likely pass, uncertainty over the details could extend toward a new deadline in late January, with Boris Johnson likely to call for an election in either case, in hopes of receiving a stronger mandate in the event that Brexit is delivered, or because it is not delivered, but the blame for non-passage is given to Parliament.
As for sterling reaction to outcomes from here, we assume around 2% of additional upside potential for sterling on the deal passing tonight and a bit more in subsequent days if the compressed timeline is approved and we are clearly moving for an Oct 31 exit. Without the short timeline approval, sterling price action could prove more significantly two-way. Even with Brexit delivered by October 31, we suspect price action calms markedly as we may have already priced in the lion’s share of the short term potential for sterling, where considerable damage to the economy must be repaired from here to support fundamentals for the currency beyond the immediate, “release of uncertainty” supporting capital flows angle.
Outside of Brexit, the issue that exercises us the most is the rise in long bond yields and apparent correlation with JPY and USD crosses – we have discussed this in recent days and in the chart below, but we are getting near the “pain point” for US yields as the 1.9% prior high and especially the 2.0% level approaches for the US 10-year yield benchmark. Above that level and the narrative changes – for now, we would prefer to look at what might happen if support for bonds comes in near current levels on the assumption that more negative data is incoming. At that point, the heavy lifting for yield curve steepening would have to come from Fed cuts taking the short end lower.
The Canadian election sees Prime Minister Trudeaus staying in power, but with a reduced mandate and a minority government. The CAD hardly reacted, as recent CAD strength has been driven by the remarkable divergence in the Bank of Canada policy outlook, where 2-year rates in Canada have climbed well above their US counterparts. This justifies a USDCAD challenge of 1.3000, but is the rate outlook for the BoC justified if the US economy is headed for a recession in the coming quarter and taking the Canadian economy down with it?
Chart: EURJPY, AUDUSD and German 10-year
Correlation across positions may prove difficult to escape here if global long sovereign yields continue to move as quickly as they have recently, with higher longer yields and yield curve steepening coinciding with the recent weakness in the US and in the JPY. Here we have illustrated with a Bloomberg chart showing AUDUSD, EURJPY and the German 10-year Bund yield. The correlation is easy to spot and if the mood changes and support comes in for safe haven fixed income, we will likely see a pivot in USD and JPY pairs.
The G-10 rundown
USD – the greenback making a modest comeback this morning after extending weakness as we watch the shape of the US yield curve (mostly driven by long end at the moment, but possibly by the short-end on the next important US economic data on the risk of accelerated rate cuts) as a coincident indicator on whether the dollar is turning profoundly lower.
EUR – consolidation in EURUSD needs to stay well above 1.1000 to keep bulls comfortable and a takeout of 1.1200-25 is the next key for unlocking upside potential and a more structural shift in the chart.
JPY – the outlook dominated by the direction in long bond yields – have the likes of EURJPY and other JPY crosses gone too far too fast?
GBP – key short term sentiment test for the market on today’s first vote, as momentum has increasingly priced in soft Brexit news over the last couple of weeks. Also the risk that subsequent votes not to approve the compressed deadline leave residual uncertainty.
CHF – franc traders watching Brexit with one eye and risk appetite with the other – a bit surprised, as we have noted before that the backdrop hasn’t provided more pressure on the franc to weaken recently.
AUD – a big pivot point in AUDUSD just shy of 0.6900 as we watch whether risk sentiment can continue to climb the wall of worry here.
CAD – as noted above, the markets assessment of relative central bank rate trajectories suggests USDCAD should be where it is or even lower, but is the rate assessment in for a surprise in coming weeks? 1.3000 a critical level for USDCAD
NZD – the kiwi outpacing the Aussie here, with AUDNZD perhaps warming up for a deeper consolidation after all – the key area lower perhaps around 1.0550, where the 200-day moving average currently resides.
SEK – EURSEK needing another leg lower to administer the knock-out blow for the recent rally wave, and the 10.60 level important as recent range low and location of the 200-day moving average. The Riksbank is still seen as bent on exiting negative rates, if on a very slow schedule – Riksbank meeting up on Thursday.
NOK – EURNOK consolidating after its steep run to record highs – where would this move have gone had the backdrop not been so supportive (strong risk appetite and strength in smaller currencies recently)? Yes, oil prices and importantly, gas prices have been weak, but we are also set for a seasonally weak period for NOK into year end.
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