The main moves yesterday happened after the European close with Cable (Sterling-Dollar) pressured lower on both sides of the cross. First came the US Federal Reserve September meeting minutes at 7pm BST. The Fed continued to advocate a gradual approach to rate hikes, but a number of officials cited the need to raise rates above the long-run level. This gave the minutes an outright hawkish tone. The Dollar index immediately rose, ending the day 0.6% higher. The US 10-year yield surged following the release, reaching a high of 3.2107% in early Asian hours this morning. This is dangerously close to the 3.25% level that sparked a dramatic sell-off in bond and equity markets last week.
The response of equity markets this time around was lesser, but the declines were more moderate. China’s Shanghai Composite opened lower and is now 2.03% weaker from yesterday’s close. The FTSE All-Share index is down a more moderate 0.73% on the day. We believe rational thinking will kick-in. The Fed’s minutes were relatively stale, detailing a meeting that occurred before US yield rises sparked simultaneous sell-offs in bond and equity markets. Financial conditions are part of the Fed’s reaction function, and recent market moves support a more cautious approach from the US central bank. US growth and a strong earnings season should keep equity markets supported in the near-term.
The Brexit news flow began from 6pm BST as national leaders and EU officials arrived for the October Summit. Leaders struck a conciliatory tone when speaking to the press, cautious not to repeat their aggressive tone seen at the Salzburg summit which caused much criticism in the UK. Following Prime Minister Theresa May’s speech and the working dinner, news started to trickle out. EU Parliament President Antonio Tajani said the tone of May’s speech was positive, but there was no new content. He also said that both sides in the summit mentioned extending the transition period. The idea of an extended transition to provide more time to agree on an EU-UK free trade deal and avoid the need to use the Irish border backstop is gaining more traction.
Then came the biggest blow for Sterling. EU leaders are not planning an extraordinary summit in November, for now, and will only call a meeting if there is significant progress in the coming weeks. A November summit had been speculated as a potential date to formalise and sign off a Withdrawal Agreement between the UK and EU. The 13th-14thDecember EU summit is now the one remaining scheduled opportunity for the UK and EU to hash out a Withdrawal Agreement, bringing negotiations incredibly close to the 21stJanuary 2019 deadline. This is the final date the UK and EU Parliaments, as well as the EU Council, must have voted on the deal.
The EU has a history of last-minute negotiations, so the lack of a November summit is not a significant risk to an orderly soft Brexit. However, the reaction of UK politicians to the idea of an extended transition deal is. In a joint open letter, Tory Eurosceptics stated the British people would not forgive May if Brexit was reduced to a ‘choreographed show of resistance followed by surrender’. Nigel Farage, former Ukip leader, said such a move ‘may mean we never leave at all’. There were further calls for May’s resignation. An extended transition period means continued payments into EU budgets and extended free movement of people. It also comes with single market and customs union membership, restricting the UK’s ability to strike its own deals. Even if the new proposal wins favour with the Democratic Unionist Party, it would put the Withdrawal Bill’s parliamentary vote tally at 245 MPs for, and 405 against. Theresa May would need to rely on a substantial number of Labour MPs defecting and supporting the agreement.