Crystal balling Brexit
Today's news headlines:
- ‘Sterling stumbles after Johnson's Ministers stir no-deal Brexit fear'. Despite adopting a 'leave with a deal' goal, Boris Johnson has declined to meet with EU leaders because of their unwillingness to reconsider the Irish backstop. The first potential meeting with EU leaders will be the G-7 in late August. (Financial Times)
- ‘Italy's economy struggles to escape stagnation'. Italy's economic activity, due out tomorrow, could suggest Italian real GDP growth will be lower in 2024 than it was in 2007. As is the case in much of Europe, the real worry is in the manufacturing sector. The Bank of Italy's Ita-coin, a cyclical coincident indicator of economic growth, has been showing an increasing rate of stagnation since Nov 2018. (Financial Times)
Mind the gap
So, what happens when markets finally begin to price in a no-deal Brexit? Well, yesterday was our first taste. The Pound Index has lost over 3.0% of its value over the last four days as the ‘hard-Brexit stars’ align under Boris Johnson’s premiership. Cable sank below the $1.22 level for the first time since March 2017 and faces little resistance down to $1.20.
Johnson has refused to meet with EU leaders until the withdrawal agreement is re-opened, which has caused investors to run to safe-haven assets. The price of gold in Pounds has risen towards an all-time high, and the 10-year government bond yield has slipped as low as 0.63%—the weakest since August 2016. A secondary reason for the rally in bonds is that markets fear that the Bank of England (BoE) will shift towards a neutral bias in this week’s monetary policy meeting.
Plenty of analysts are forecasting further misery for the Pound in the near-term. Kyle Rodda of IG Markets notes the significance of the Pound’s move below 1.22 against the Dollar and predicts we may see $1.18 in the coming months. These sentiments are echoed at both ING and Nomura as they forecast a no-deal outcome could push the Pound towards the €1.05 and $1.15 levels respectively.
Bottom line: ‘Crystal balling’ Brexit is an impossible task and markets are so tired of the topic that most don’t attempt to quantify Sterling valuations any longer. What we see instead is a wholesale, collective reach for safety. Government bond yields are plumbing new lows, and the Pound seems destined to follow suit.
Overnight, as expected, the Bank of Japan (BoJ) kept interest rates on hold, which highlights the challenge facing central banks with zero interest rate policies. While the BoJ cut its growth and inflation forecast by 0.1%, it kept its interest rate at -0.1% and asset purchase program unchanged. In the accompanying commentary, it highlighted additional stimulus would be used if the bank cannot achieve its price stability objectives. More importantly, they were quick to downplay the need to ease policy, suggesting the Fed cut had already been priced in and further Yen appreciation wasn't likely.
We can understand the bank's quandary. The central bank is likely waiting to see how Fed policy guidance will steer the Dollar so it can deduce the impact on the Japanese Yen. Current market expectations of continued Fed cuts have caused assets to rally rather dramatically over the past several weeks. An unwinding of this dynamic—assuming the global outlook hasn't materially improved—is likely to put upward pressure on the Yen, dampening Japanese exports and inflation. As one of the first nations to experiment with negative interest rates, going further into negative territory is a bold step.
Bottom line: The BoJ doesn't have as much capacity to cut interest rates like other central banks, so a 'wait-and-see' policy may be the best option for now.
The Dollar's appreciation has appeared to slow after an almost two-week run. The Pound, on the other hand, has been sold rather dramatically through the low of the current range to levels last seen when Article 50 was triggered in March of 2017. The further downside on the pair seems likely given Dollar support leading into the Fed meeting tomorrow and the absence of support for the Pound.
The Euro has been the beneficiary of Sterling selling, which has nudged the pair through the bottom of the trading range and to August 2017 lows. Unlike GBP/USD, the support for EUR is less adamant, so the pair is likely to find support at previous lows near 1.08. A raft of EU data out tomorrow and Thursday may serve to balance the scales if the Bloomberg forecasts are to be believed.
Despite numerous attempts for a push lower, the pair seems well supported at the bottom of the trading range. A 25bp cut from the Fed is already priced in so, we wouldn't expect this to have an impact on rates. We suspect that the Fed may accompany the cut with some hawkish statements aimed at reigning in overzealous markets, which might actually have a beneficial effect on the EUR.
All content is written by the Global Reach Trading Desk. The opinions expressed are not the view of Global Reach Group and are not intended as investment advice.