Sterling wilts on no-deal risks

Currency traders continue to hold their collective breath until the Xi-Trump summit at the G20 meeting this Friday and Saturday. Meanwhile, sterling is edging lower again as the market recognizes that May’s Brexit deal is unlikely to pass a December parliamentary vote, raising the risks of a no deal, or perhaps even worse for the currency, a Corbyn Labour government.

A flurry of activity in early European hours this morning in all things China-linked (for example, a brief pump-and-dump in AUDUSD and Nasdaq futures) after a Chinese foreign ministry spokesman’s words were over-interpreted and suggested that a new development was afoot, when in fact he was only referring to the November 1 Xi-Trump phone call and the intent expressed to reach an agreement on trade. 

Most currencies are locked in nervous ranges ahead of the Xi-Trump meeting to take place at the G20 summit in Buenos Aires on Friday and Saturday. We’re far from hopeful that anything promising will emerge from the meeting, although some sort of short-term ceasefire in the hostilities to allow for further discussions could be in the offing and produce a modest risk-on rally into year-end. Even that may be too much to ask.

Note that this evening the Reserve Bank of New Zealand will publish its latest Financial Stability Report and RBNZ Governor Orr will discuss the report at a news conference and later before a Parliamentary committee. Orr has been one of the more consistent doves among central bankers, but the kiwi got a boost earlier this month from strong wage data. Much of the jump in short NZ yields has been unwound over the last two weeks, so the support for the strong kiwi is rapidly fading and a dovish spin on the FSR could change the tune for the currency.  Regardless, any immediate reaction risks getting bottled up until the other side of the Xi-Trump summit.

Watch out for the recently appointed Federal Reserve’s Clarida (Federal Open Market Committee voter and on Fed’s board of governors) out speaking later. His most recent appearance was read as dovish as he advocated more data-dependency for further rate hikes from here. Fed chair Powell is out speaking tomorrow at the New York Economic Club and the FOMC minutes of the November meeting are up on Thursday. All in all, we should have a sense of whether Powell will continue to downshift the urgency level or keep his cards close to his vest. Given a 30%-plus reversal in crude oil prices from the top, the market is likely to take the October PCE inflation data with more than a grain of salt. More important will be the next average hourly earnings data next Friday .

Besides, this Fed is likely highly reactive to Clarida’s incoming data and the latest sense of the US-China trade relationship after this coming weekend. A Fed guidance change to the dovish side is most likely to coincide with rather alarming prospects for the US economy, so any celebration in risk assets may be rather short-lived. Recall that back in 2007, the Fed cut by a chunky 50 basis points in September and the equity market rallied for just under a month before lurching into a historic collapse. Back in 2001, the first rate cut came over nine months after the top in tech stocks and a few months after the broader market top in equities, although that first cut did generate an epic and short-lived short squeeze.

I would lean more toward a 2001 setup rather than a 2007 setup this time around. And my underlying assumption is that the USD could have a hard time falling despite a Fed climbdown as long as risk appetite is faring poorly.

Chart: GBPUSD

Cable is nearing its recent lows and looking heavy as it is quite clear that the current deal won’t pass a December parliamentary vote without a significant change of attitude from a large swath of MPs (marginally possible if, as one pro-deal Tory indicated, the popular exhaustion with the issue is so profound that the average Brit just doesn’t care anymore). Regardless, the odds of a no-deal Brexit are as high as they have ever been, and the route to a stronger sterling is difficult if the two alternatives are no-deal on the one hand (albeit one that is non-the-less extended for practical reasons to avoid excessive disruption) and on the other, a new election pointing to Jeremy Corbyn as prime minister. Below 1.2661, there’s not much support until 1.2000 save for a round number like 1.2500.