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And now back to Westminster

Today's news headlines:

  • ‘Progress made in Irish border Brexit backstop negotiations’. The most important development would be that the EU seems close to agreeing that the backstop would apply to the whole UK and not just to Northern Ireland, as it originally demanded. (ITV News)
  • ‘Up to 30 Labour MPs on fence over Brexit vote’. Up to 30 Labour MPs are considering defying their party leadership and voting for Theresa May’s Brexit deal – or abstaining – because they fear the economic consequences of the UK leaving the EU with no agreement. (The Financial Times)
  • ‘Trump says summit with Kim Jong Un will be after midterm elections’. Speaking to reporters as he flew to Iowa for a political rally, Trump said: 'It’ll be after the midterms. I just can’t leave now.’ (CNBC)
  • ‘IMF warns of possible emerging–markets crisis’. Most countries expect to see growth, but ‘severely adverse’ scenario projects capital outflows not seen since the last decade. (The Wall Street Journal)

In yesterday’s morning trade, Italy’s Finance Minister Giovanni Tria stole the markets attention, but for all the wrong reasons. Giovanni Tria was supposed to be the moderator between financial markets and Italy’s controversial new governing coalition. Yesterday, he tried to desperately appease both sides. In his speech to Parliament, Tria explicitly backed the ruling coalition’s move away from austerity towards fiscal expansion. Tria stated that Italy’s recent low growth had not allowed for a debt-to-Gross Domestic Product (GDP) cut, and that economic growth was the only way to improve public finances. His beliefs were clear; the only way for Italy to reduce its 131.0% debt-to-GDP ratio is to grow its way out by increasing spending.

In response, Italy’s yields began to edge ever higher, breaking the previous multi-year high on the 10-year. The Euro gave its typical muted response, dropping just 30pips against the US Dollar. With the 10-year yield rising to 3.711%, Tria returned to the wires. This time he was desperately trying to appease financial markets and stop the selling of Italian debt, saying: ‘Government made it repeatedly clear commitment to the Euro…. Deficit to be lower if government not able to implement plans… Italy’s current government bond yield spread is unacceptable’. His pleas worked. Yields began to decline, and the Euro stabilised. The market reaction shows fears about Italy’s fiscal sustainability remain alive and this could be a downside risk for the EUR as we approach the October 15thdeadline for Italy to officially submit its budget to the European officials.

Overnight the biggest mover was the Pound as news broke that the EU was supportive of the UK’s latest proposal for the Northern Ireland backstop issue. It was reported that the EU seemed closed to agreeing that the backstop would apply to the whole UK and not just to Northern Ireland. If the news is to be believed, this would satisfy the Democratic Unionist Party’s only red line – for the UK to leave the EU as one nation, one customs union. Another positive development was that although this customs arrangement solution to the Northern Ireland issue is supposed to be temporary, the EU doesn’t look to be setting an expiry date.

Sterling edged consistently higher as the news broke, and in the European morning, was trading around the 1.31 level against the Dollar. The FX market’s relatively conservative reaction is because risks remain. After a seemingly established agreement with the EU, the ball lands firmly back in Westminster, and the Eurosceptic fraction of Prime Minister Theresa May’s party. The UK’s proposal is the legal equivalent of a fudge or a kick the can down the road agreement, with the backstop being that the UK essentially remains in the EU customs union without an end date. Will this be palatable to the hard core Brexiteers? The proposal would limit the UK’s ability to do trade deals with other countries. Both UK Houses of Parliament need to approve any agreement between the EU and UK. The treaty may not be ratified if either House decides so under Part two of the Constitutional Reform and Governance Act 2010. It’s back to watching Westminster headlines to see how feasible this soft Brexit agreement really is.

For the day ahead, the UK’s Trade Balance has surpassed market expectations for the last three months on consistent increases in the UK’s trade services surplus. The official release of the UK’s industrial and manufacturing production stats for August are likely to show slowing growth in the sector based on leading survey indicators. However, the UK Manufacturing Purchasing Managers’ Index (PMI) already suggests growth recovered in September, making this release relatively stale unless it can surprise.

The US Producer Price Index (PPI) is likely to be the most important release of the day as financial markets equate price pressure to the pace of Federal Reserve tightening. The question at the Federal Reserve, and for markets, is can the US continue this pace of stellar growth without stoking inflation? The PPI’s August downtick predicted a slowdown in inflation for the month. Could the cryptic cycle of Fed tightening, a stronger dollar, and lower US non-oil import prices be keeping inflation tame? Or is it the result of a bigger structural shift? Whatever the reason, US inflation is an important input into expectations for Fed policy tightening. The US October 5th MBA Mortgage Applications and August final Wholesale Inventories will also be released. Canada’s August Building Permits will show how higher interest rates are impacting the sector.

The Fed’s centrist James Bullard and doves Charles Evans and Raphael Bostic speak on relevant topics on the economy and monetary policy. The Reserve Bank of Australia’s (RBA) Assistant Governor Luci Ellis speaks in the evening.