Brexit beleaguers the Pound

Today's news headlines:

‘Not bound by EU budget rules – Salvini’. The Italian government does not ‘feel bound by the norms of public deficit decreed by Brussels and which many European governments have ignored, starting with France, Spain and Germany’, Deputy Premier Matteo Salvini said after the country ratified their draft budget and sent it to the EU Monday. (ANSA)
‘Donald Tusk: No deal Brexit “more likely than ever”’. A no-deal Brexit is ‘more likely than ever before’, European Council President Donald Tusk warned in a letter to EU leaders Monday. (Politico)
‘Eight cabinet ministers with concerns over May’s Brexit backstop at Andrea Leadsom’s “pizza summit”’. Andrea Leadsom, the Leader of the Commons, hosted the meeting where: Dominic Raab, the Brexit Secretary; Jeremy Hunt, the Foreign Secretary; and Michel Gove, the Environment Secretary were among those in attendance. (Telegraph)
‘Facing heat, Saudi could admit Khashoggi died in “botched op”: Report’. US officials are predicting that the Saudis will inevitably admit complicity in the death of Khashoggi and claim a ‘botched operation’, said one person familiar with the discussions. (Fox News)
‘Japan’s Aso: FX topic not usually raised in trade discussions’. The comments from Japan’s Finance Minister Taro Aso follow remarks from his counterpart Steven Mnuchin that the US want a currency clause in a trade agreement with Japan. (Bloomberg)

The US Dollar was the underperformer in yesterday’s trade. The Greenback ignored the relative stabilisation is US Treasury yields and instead, once again, took its cue from equities. The weak performance in Asian equities in the early hours yesterday spilt over into European stock markets and then into the US. The moves were most clearly seen in the Dollar – Japanese Yen (USD/JPY) cross, the currency market’s risk sentiment barometer. USD/JPY pushed below 111.70 as currency markets caught the risk-off chill coming from equities. The level was within a one-month low for the cross, showing how much risk-sentiment has soured recently.

One currency managed to beat the Dollar’s dour performance yesterday – the Brexit beleaguered Pound. Weekend headlines reported a breakdown in negotiations between the EU and UK over the Northern Ireland backstop part of the Withdrawal Agreement. This set the tone for the currency on Monday’s open, and there was little that could be done to dissuade negative Brexit sentiment, despite UK Prime Minister Theresa May’s attempts.

Mrs May stepped up in front of the UK House of Commons to try and ease concerns and appeal to MPs to pass the new deal. However, there were no signs of a new solution for the Northern Ireland border issue. Instead, May could only downplay its importance and underline that the solution on the table is temporary. First, May reiterated that the backstop is ‘an insurance policy’. Both parties are ‘committed to ensuring that this future relationship is in place by the end of the implementation period’ and the backstop would only be used if ‘a temporary gap were to arise’. Secondly, May pledged that the backstop would be temporary, saying: ‘I am clear we are not going to be trapped permanently in a single customs territory unable to do meaningful trade deals’. May appealed to lawmakers to not ‘let this disagreement derail the prospects of a good deal and leave us with the no deal outcome that no-one wants’.

The Prime Minister made a convincing case, but her words will not change what is written in the legal text of the Withdrawal Agreement. Her personal reassurance fell on deaf ears given that UK politicians have talked openly about a Conservative leadership challenge or early general election which could see her replaced. The Pound received a temporary boost on her comments before a whirlwind of Brexit developments undermined May’s attempts at damage control. In the European evening, EU Council President Donald Tusk stated that a no-deal Brexit was ‘more likely than ever before’. Later it was reported that eight UK Cabinet ministers met Monday evening to discuss concerns about May’s Brexit plans. The seniority of the eight reinforced concerns about the current withdrawal deal passing through Parliament.

Sterling remains on the back foot and waits for further developments from a crunch time UK Cabinet meeting today, and the all-important EU Council summit dinner tomorrow. We continue to look for Pound near-term volatility and see lower levels of Sterling in the near-term. Things are likely to get worse before they get better.

In the day ahead, the UK August employment report will show that the economy is quickly approaching its capacity limit. The unemployment rate fell to a four-decade low in July, while regular pay growth from May to July quickened to 2.9% annually, rising 3.1% alone on the month. With productivity growth stalling, any increase in wage growth is inflationary, underpinning the Bank of England’s (BoE) predicament in keeping interest rates constant ahead of Brexit. Eurozone August Trade Balance data is expected to rebound modestly after remaining on a downward trend since the beginning of 2018. A stronger trade-weighted Euro and softer demand from Asia is impacting the Eurozone’s export growth, a particular problem for Germany. The Eurozone October ZEW Expectations of Economic Growth will also be published.

In the afternoon session, the focus will be on the US September Industrial Production reading. Strong gains in the volatile utilities and auto vehicles sector led to an increase in August, and have many expecting a moderation in September. Surveys of US manufacturing suggest resilient growth in the sector despite a slowdown in output expansion in recent months. This will be followed by the US October NAHB Housing Market Index and the August Treasury International Capital report. The Reserve Bank of Australia’s (RBA) Guy Debelle will speak at some point on Tuesday. The fact he is delivering the speech to a Citi conference means it should have something of interest for financial markets.