05 Feb 2019: Sterling “reaching for Brexit Straws”

Sterling “reaching for Brexit Straws”

February 5th: Highlights

  • One-way customs plan lifts the pound
  • Dollar steady as the market continues to digest FOMC and NFP
  • Italian resentment grows as bond spreads widen

EU goods could be “waved through” Brish customs post-Brexit

The fragile nature of the financial market’s concerns over Brexit were perfectly illustrated yesterday. The pound briefly gained following a story that UK customs may alleviate any post-Brexit log-jam at UK ports by suspending checks on goods arriving from the EU.

It is hard to imagine such an arrangement being contemplated let alone agreed and the market quickly settled back into the waiting game that has developed before the Prime Minister reports back to Parliament next week. Given the continued hard line being taken by Brussels, there is unlikely to be any breakthrough with regard to even reopening talks about the Irish backstop, let alone reaching an agreement.

Finding any form of agreement that could pass through Parliament is starting to resemble alchemy. There is a considerable degree of effort being put in to avoid a no-deal Brexit, but the fact remains that with just 52 days to go all parties are still nowhere near a proposal to put to the EU and Brussels remains firmly entrenched in its position.

While the UK may well be left with no choice than to leave with no-deal there are murmurings coming from various EU businesses with strong links to the UK within their supply chain that the EU must be more accommodating as the EU economy is suffering enough without a further shock to its growth prospects.

It may well be that it is the shock of a no deal Brexit actually taking place that drives all sides into action since both sides will see a real challenge to their “we don’t need you” attitude.

Yesterday’s data releases in the UK were hardly supportive before the MPC meets this week. Construction activity fell close to contraction as Brexit nerves continue to affect the building industry.

The pound reached a high of 1.3103 before falling back to a low of 1.3028 and closing at 1.3038.

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Dollar reacting to tentative global optimism and higher yields

The dollar index, which values the greenback versus six of its trading partners, rose to a high of 95.92 as it continued a recent run of gains. Global risk appetite continues to improve as the downbeat reaction to last week’s FOMC meeting fades. It seems that the FOMC will have a fine line to tread going forward as on the one hand, it pauses in its rate hike cycle which promotes domestic growth concerns while, on the other, not hiking reflects the reality of the economy.

Rising risk appetite saw a rise in U.S. Government bond yields as their requirement as a safe haven play evaporated. This, in turn, also provided support to the dollar.

The picture going forward is mixed at best as inflation is well controlled which provides the Fed with another reason to “sit on its hands” while the antipathy between the President and the Leader of Congress could blow up again at any time.

President Trump is clearly rankled by having to have agreed even a temporary deal to end the Federal shutdown without receiving any money towards building the Southern Defense Wall. As negotiations start up again, there is no guarantee that the situation won’t go downhill very quickly.

Having risen throughout the day, the dollar index closed close to its high at 95.82.

Italians falling out of love with “all things Europe”

It used to be considered a truism that Italians love the EU but hate the euro.

That situation is starting to change for the worse. Rome has found Brussels almost as intransigent and difficult to deal with as the UK has. The Nationalist Government was forced to rein in its proposed budget deficit for 2019 from 2.4% to 2.04% at Brussels insistence. With its debt to GDP ratio to continue to grow over the next few years and with that more forced austerity, the love affair with even the EU looks to be coming to an end.

While it is a long way from even being considered by the mainstream, the possibility of an “Italexit” is not as far fetched as it was once thought. The issue is that if a country is forced from the eurozone, what does that do to its EU membership? It is certain that upon leaving the euro, Rome would also find itself in contravention of the growth and stability pact which applies to all members of the EU not just those in the Eurozone.

If the Government is emboldened by the results of the elections that will take place in May, such a scenario could easily come to pass.

For now, the single currency remains in the doldrums as inflation data confirmed the recent ECB statement that it will be several months before prices begin to rise again, even if wage data starts to improve. It traded in a narrow range yesterday between 1.1488 and 1.1424, closing at 1.1434.

With services activity and retail sales data to be released later, the euro could come under further pressure this morning.

Have a great day!

About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”