The font of rumour
Today's news headlines:
- ‘Deal in fresh doubt as Johnson’s allies say no: Brexit update’. The Democratic Unionist Party (DUP) has said it could not back Johnson’s deal ‘as things stand’, highlighting customs arrangements, consent issues and lack of clarity on VAT as the sticking points. Johnson’s government relies heavily on being backed by the DUP for a Brexit deal to be agreed within the UK. The DUP said it would continue to work with the government to find a suitable arrangement. (Bloomberg)
- ‘House condemns Donald Trump for Syria withdrawal’. Trump claims his actions to withdraw American troops from north-east Syria produced a ‘strategically brilliant’ outcome, but the US House of Representatives strongly disagrees. The House passed a resolution condemning his actions after it voted 354-60 along with all 225 Democrats to demonstrate disapproval. With Trump already facing an impeachment inquiry, the House’s opposition adds to growing tensions between Trump’s Presidency and the White House. (Financial Times)
Behind the curtain
The endless font of Brexit negotiation rumour has resulted in a spectacular series of market panegyrics. The thirst for Brexit certainty is so great that it overawes our reasoning faculties, suspends all fundamental analysis of the UK economy, and causes us to resort to some primordial ‘buy Sterling’ reflex.
Let’s break form and look at the facts for a moment. GDP growth is forecast to be 1.0% next year, the lowest since the financial crisis, and Bloomberg estimates the probability of recession at 40%. Despite record levels of employment—setting aside the valid concern that zero-hour contracts distort this statistic—household consumption is set to be the lowest level in seven years. All three Purchasing Managers' Index measures of sectoral performance suggest contraction. A debate with an economist who argues the Pound should trade at pre-referendum levels would be entertaining; all the pesky facts would be against them, and all they could summon in aid of their position would be the tired trad of the Empire’s past glories.
The nominal effective exchange rate shows that the Pound is trading 6% below the current ten-year moving average, which equates to 1.35-36 against the Dollar, and 14% below the 2015 pre-referendum ten-year moving average. If we turn to the OECD Purchase Power Parity reading—which measures relative purchasing power based on a common basket of goods—the most famous of which is The Economist’s Big Mac Index, it shows that the Dollar is 10% overvalued and the Euro is 11% undervalued versus the almighty Pound.
Bottom line: To think the Pound should regain all of that ground versus the Dollar is unreasonable. US economic fundamentals far outstrip UK readings, so to presume a removal of Brexit uncertainty would cause a flood of investment into the UK is fanciful at best. That is, of course, before we even consider that a new Scottish independence vote is likely to displace Brexit uncertainty in newspaper headlines. There is so much optimism baked into this Sterling appreciation that we find our appetite for fresh rumours is not quite what it was.
Yesterday’s session was volatile for Sterling as headlines and comments emerged from key players in the Brexit negotiations. The pair reached highs of 1.2877 yesterday afternoon before settling overnight around 1.2820. In the London open this morning, comments from the DUP opposing Johnson’s deal sent Cable lower, finding support at 1.2750. Another volatile day should be expected as Brexit negotiations unfold, with potential support at the 200-daily moving average at 1.2714.
With the Euro still trading in low volatility, the currency cross is still very much directed by Sterling pressure. The pair reached five-month highs of 1.1631 in yesterday’s session, but the London open sent the pair lower to 1.1520 on comments from the DUP. Further Brexit negotiations are taking place today, so intraday volatility should be expected.
The common currency continues to trade with low volatility and in the steady upward trend that has occurred in October. The pair hit four-week highs of 1.1087 overnight as the trade-weighted Euro Index traded just ten basis points shy of its 50-daily moving average—a key level that may provide resistance for the pair in today’s trading.