Friday brought another Brexit headline boosting the Pound on increased probability of a Brexit deal before the March 2019 deadline. The EU’s chief Brexit negotiator Michel Barnier reportedly loosened his stance on the Irish border, one of the most contentious issues in negotiations, and called the UK’s White Paper ‘useful’. Our base case is that EU calendar constraints will force an agreement or extension before the March deadline. The EU faces a hectic schedule with parliamentary elections in May, the EU’s next multiyear budget, a potential budget conflict with Italy, and a US trade war. The safe passing of Sweden’s general election this Sunday and reduced risk of a Swedish referendum on EU membership means that EU will be less worried about the example Brexit negotiations set for other countries. Sterling will continue to trade at the mercy of the Brexit news flow, but the greater risk is to the upside for the Pound on progress towards an agreement.
Friday’s gleaming report card on the US labour market lent support to the Dollar as the market took a September Federal Reserve rate hike as practically guaranteed. The US economy added 201K jobs in August, beating expectations of 190K; though the number was partially offset by downward revisions to prior months. The real showstopper was wage growth, which rose to a nine-year high coming in at 2.9% on an annual basis. Inflation is in the pipeline, a clear sign for the Federal Reserve that the economy is in an aged expansion and risks overheating. In the medium-term, we see the Dollar’s ability to strengthen further as limited. The rates market has almost priced in the full Fed rate hike path, and the flattening US yield curve has its own implications for market tightening expectations.
Politics continued to drive markets on Friday afternoon as US President Trump’s comments hit the wires. Trump warned that the planned tariffs on USD200bn Chinese imports ‘could take place very soon’, and warned of an additional ‘USD267bn ready to go on short notice’. The classic safe-haven currencies, the Swiss Franc (CHF), Japanese Yen (JPY) and the US Dollar rose on the news. The long-term implication of trade wars is the potential unravelling of global supply chains. Short-term, the implication is inflation. July US inflation already crept higher on rising costs of industrial metals and fuel; signs that tariffs were already being passed on to consumers. August’s US Producer Price (PPI) and Consumer Price Indices (CPI) will be released this week putting the cost of trade wars in sharp focus. The Fed has to balance inflationary pressure with the emerging market sell-off, housing market slowdown, and risk of yield curve inversion. The Fed is likely to look through the one-off inflationary effect of trade tariffs that will fall out of calculations next year and proceed with its rate hike path as planned. It has a lot more to worry about.
For the day ahead, the UK’s July Trade Balance number will be released and will, of course, remain in negative territory. Sterling’s post-Brexit devaluation was an instant boost to exports, but unfortunately, imports increased by almost as much. US Consumer Credit will be released in the afternoon, and the Fed’s Raphael Bostic will speak on the economic outlook. Considering the market was updated on his moderately hawkish stance last Thursday, we do not expect the market to be caught off guard.