Theresa May: Playing poker with your home team showing your cards

Today’s news headlines:

  • ‘China cancels trade talks with U.S. amid escalation in tariff threats’. Move comes after U.S. announces tariffs on USD200bn of Chinese goods. (Wall Street Journal)
  • ‘”Majority of Cabinet” now supports move towards Canada-style Brexit deal’. The Prime Minister is expected to hear this news following the EU’s outright rejection of the Chequers plan. (Telegraph)
  • ‘Brexit: Labour would back members on new vote, says Corbyn’. Labour leader Jeremy Corbyn has said he would be ready to back another EU referendum, if party members want one. (BBC)
  • ‘Theresa May’s team plot snap election to save Brexit’. PM faces new Cabinet battle over immigration. (The Times)
  • ‘Italy PM spokesman threatens vendetta unless Treasury finds welfare funds’. An Italian spokesman has warned that the anti-establishment 5-Star Movement in the coalition will sack Treasury officials in ‘mega-vendetta’ unless they find the resources needed for welfare spending. (Reuters)
  • ‘Italy’s Salvini pushes back against central bank’. Deputy Premier wants ‘courageous’ budget; deficit no problem. (Bloomberg)

Friday saw the slow trickle of rumours and speculation reach markets; eventually, UK Prime Minister Theresa May confirmed the rumours and resorted to her fall back threat to the EU - no deal is better than a bad deal. Around 8:30am on Friday, a Conservative MP tweeted a major announcement was coming from PM May. Sterling started the day around 1.3272 against the US Dollar (GBP/USD), but began to slide. May’s humiliation and the rebuke of her Chequers proposal at the Salzburg summit were clear. Speculation swirled that May would purpose an alternative to her Facilitated Customs Arrangement solution to the Northern Ireland border, one among them an inland border for border checks. The announcement was later denied by a credible source close to No.10. However, when a Telegraph source confirmed a time for the announcement, the market took note, and Sterling slid further.

Close to 2:00pm on Friday, the rumour was turned to reality as May speaking at No.10 confirmed the EU was at an impasse. However, May did not purpose an alternative solution to the unresolved Northern Ireland land border issue. In a rejection to the EU’s stance that only two options are on the table—EEA and customs union or a Free Trade Agreement—May set out her mandate. She will not accept anything that threatens the integrity of the union and anything that doesn’t respect the referendum. Then, she repeated her familiar last resort threat: ‘no deal is better than a bad deal’. Sterling traded down to a low of 1.3056 against the dollar, its biggest one day fall in 2018.

It’s hard to play poker with 40 Brexiteers behind you showing your cards. Theresa May’s negotiation position has always been weak, especially sitting across the table from the EU—the bigger market and bigger economy. However, despite the recent rhetoric around globalisation and trade, international trade is not a story of winners and losers, but of mutual beneficiaries. Despite the impending Brexit, UK services exports to the EU surged in 2018. The EU has a £95 billion goods trade surplus with the UK, increasingly valuable to the common market given the recent slowdown in the manufacturing sector on slowing export orders. The UK and EU economies are closely integrated, and there will be causalities on both sides of a hard Brexit.

We retain our base case of an orderly soft Brexit. For one, the EU needs the UK’s divorce settlement to fund its multi-year budget. A Temporary Customs Arrangement remains a way forward, as a UK proposal on the border issue that is acceptable to the EU. However, we admit that the risks of a no-deal Brexit have increased after Friday’s announcement. The EU’s more conciliatory tone in recent weeks may have in fact been meant to support May as her own party openly discussed a leadership challenge. The impasse over the Northern Ireland border is likely to lead GBP lower over the next few months ahead of a heavy schedule of EU meetings.  

Today’s release of Switzerland’s September 21st Domestic Bank Sight Deposits will be watched as a leading indicator for FX intervention. Ahead of France’s 2017 Presidential Election, domestic sight deposits rose sharply. This time around, it’s Italy’s showdown with the EU on its national budget as the source of market risk and reason for Swiss Franc (CHF) appreciation. Our base case is for a headline deficit figure of 2.0% of Gross Domestic Product (GDP) or lower. While this is in breach of the Stability and Growth Pact, it represents a realistic starting point for discussing flexibility with the EU. Importantly, this should be met with relief by markets as a bigger fiscal deviation appears priced in.  An increase in Swiss domestic bank sight deposits will suggest the Swiss National Bank (SNB) is preparing to intervene.

In the afternoon, Canada’s August Wholesale Trade Sales will be released ahead of the Dallas Fed Manufacturing Activity Index. Last week saw a disappointing manufacturing survey from New York while Philadelphia outperformed. However, a common theme, was rising input costs with trade tariffs taking effect. Will this trend be continued in the Dallas survey? Lower new orders and shorter delivery times in the August report suggest the headline Dallas index may moderate in September. The Chicago Fed National Activity Index will also be released. European Central Bank (ECB) Chief Mario Draghi will also speak on the controversial topics of the risks of excess liquidity and central bank communication.