Today, UK Prime Minister Theresa May steps down as leader of the Conservative Party, formally triggering the race for a successor who will try—where she failed for three years—to deliver Brexit. May will remain as a ‘caretaker’ in the role until a new leader is chosen, most likely in late July. Whoever replaces her will have the choice of trying to salvage her deal through renegotiations or other means, delay Brexit again or allow the UK to crash out without a deal on October 31st. Top Conservatives vying for the role (Boris Johnson et al.) have pledged to keep a no-deal exit on the table, paving the way for a fresh bout of Sterling weakness. Citigroup commented that positioning in the Pound has been neutral in the last month, which implies the risk of the UK crashing out without a deal is not priced in. A poll of Bloomberg forex strategists also concluded that Sterling could slip 2.0% lower if a Eurosceptic replaces May—they also noted that parliament would likely block a no-deal, limiting losses.
Bottom line: The next Prime Minister will be charged with delivering Brexit at all costs or risk a general election/second referendum scenario. Markets have also started to price in a Bank of England (BoE) rate cut over the next six months as a no-deal situation would require the central bank to take measures to support the economy. This is a similar dynamic to 2016, pre-referendum, but the BoE Governor, Mark Carney, has intimated quite the opposite; we might, in fact, see rate hikes if the economy performs as expected.
Vice President Pence said the US still plans to impose tariffs on Mexico next week, which means the US is standing firm on using the trade tariff lever to achieve its policy goals. Meanwhile, China has boasted a large arsenal of policy tools to support itself amid its ongoing trade war with the US. Trade conflicts instigated by the US have had a detrimental impact on global growth prospects triggering a risk-off trend that has lasted many months. This week, central banks around the world have moved away from interest rate hikes causing risk assets to rally. The Reserve Bank of Australia (RBA) has already cut rates, despite dithering for nearly a year on the point. Equities across the globe have ticked higher, and the Euro index has climbed to levels last seen in March ’19. Yesterday the ECB was surprisingly more neutral and expects future monetary policy to remain unchanged until Q2 2020. By diverging from the path set by the Fed and the RBA, the ECB risks halting the momentum building for risk appetite. Without a resolution to trade conflicts, the outlook for the remainder of the year looks bleak, and Dollar strength looks set to continue.
Bottom line: If market assumptions about the need for monetary policy accommodation were to be upset and the ECB proved right, we could see a backpedalling among Fed policymakers instead. It is too easy to fall in with the chorus of doom and gloom echoing across markets this past week. We will reserve judgement pending further data.
The trade-weighted Dollar appears to be finding support at the 50-day moving average, capping losses from early in the week. Sterling, on the other hand, seems to be trading sideways after the sell-off stalled mid-week. US Non-Farm Payrolls will be the number to watch today.
Unlike the Pound, the Euro continues to appreciate. The common currency has opened well above the trade-weighted 100-day moving average, each day posting new highs. It is unclear how long it will take for the market’s dovish rate expectation to reconcile with Mario Draghi’s more hawkish stance.
EUR/USD gains appear to be contained by the 100-day moving average. With the Dollar likewise finding support, all the pushing must come from the Euro side. Again, the Non-Farm Payrolls release later today might break the impasse.