Politics remain in focus as markets look for next direction

Today's news headlines:

  • ‘Whitehall set to issue direct orders on no-deal Brexit’. Ministers move from warning businesses to telling them to act now. (Financial Times)
  • ‘Italy tells EU it will stand firm on budget plan’. The Italian populist government refuses to curtail spending plans. (Financial Times)  
  • ‘Trump’s got a new tax plan but no details’ The President intends to push new legislation though before the mid-term elections in two weeks’ time. (CNN)

There may be some significant political questions on the table right now, but at least in the short term, currency markets appear to be marking time, waiting for the next piece of directional information. The challenge right now, however, is attempting to understand where that next line may come from – will it be a deterioration of diplomatic relations between the US and maybe Mexico, Russia or Saudi Arabia? Could we see a Brexit breakthrough? Or will it be another unknown factor that generates the next bout of volatility? The only certainty is that there’s no reason to believe the stable market conditions we’ve seen overnight will last.

The stand-off between Brussels and Rome has the potential to escalate as soon as today, following yesterday’s confirmation by the new Italian government that it has no plans to revise its budget to bring it in line with EU rules. The expectation is that the European Commission will today issue a formal censure over the country’s stance, but how this plays out has potentially significant implications for the future of the common currency. Italy has not only said it doesn’t want to leave the Euro, but that it doesn’t believe it can exit the mechanism, putting Brussels in an awkward position. The next move will be closely watched and could have the potential to reignite the idea of a two-tier currency.

With another quiet US economic calendar today, movement for the Dollar could well be directed by foreign policy. Donald Trump’s stance over the Saudi Arabian explanation for the murder of journalist Jamal Khashoggi shifted notably yesterday, but with the President evidently keen to keep a Middle East ally onside, a quick escalation here seems unlikely. Tensions are also building over what appears to be an impending humanitarian crisis on the country’s border with Mexico. A military response here may again inject a degree of panic into the market with the potential for a capital flight to safe havens, such as the US Dollar.

Brexit continues to dominate the UK agenda, with the news that Theresa May has dismissed EU demands for a backstop over the Irish border issue. This may remove some of the political uncertainty over her future – it makes a backlash from hard-line Brexiteer politicians less likely – but at the same time, it’s increasing the risk of the final outcome being a no-deal Brexit. Sterling has been essentially flat overnight against both the Euro and US Dollar, but this could prove to be a short-lived reprieve. A disorderly departure from the European Union would almost inevitably be Sterling-negative, and it will do little to encourage cash inflows via overseas investment to the UK over the next six months. 

GBP/USD

The pair has been stuck in a very narrow range since midday on Monday, but risks appear to be weighted on the downside, both from the potential for a flight to the safety of the US Dollar and a no-deal Brexit. Any sense of political stability in the UK seems unlikely to be sufficient to reverse selling pressures.

EUR/USD

Yesterday’s gains for the common currency off the back of the fact the Italian debt downgrade could have been worse proved short-lived, with the pair returning to levels from late last week. The European Commission needs to make the next move with regard to the Italian budget, but this could well serve to push the common currency further out of favour.

GBP/EUR

The cross continues to work its way lower and with the prospect of a no-deal Brexit increasing, this could maintain pressure on the downside. Political momentum, as opposed to macroeconomic factors, seem set to dominate the Pound’s fortunes.