18 Oct 2018: Sterling Falls as May Considers Longer Transition

Sterling Falls as May Considers Longer Transition

October 18th: Highlights

  • May looks to extend transition period, angers Brexiteers
  • Fed Minutes bolster the dollar
  • Euro facing political pressure

Pound breaches 1.3100 level versus the dollar

The EU summit at which a Brexit agreement was supposed to be signed off started yesterday with no sign of an agreement.

UK Prime Minister Theresa May addressed her fellow EU Heads of Government to convince them of Britain’s commitment to a solution to the issues that remain.

She was surrounded by a sense of pessimism that has prevailed since it was clear that last-ditch attempts to find a solution, primarily to the issue of the Irish border, had failed. Donald Tusk, the President of the EU Council was particularly downbeat, commenting that there were no grounds for optimism.

Tusk also called for “new facts” to break the deadlock but all Mrs. May could come up with was the possible extension of the transition period which is no solution and will hardly endear her to her Eurosceptic MP’s. They already believe the transition period to be simply a ploy to have the UK remain under Brussels control for as long as possible.

As soon as it was clear there would be no eleventh-hour breakthrough, Sterling started to tumble, reaching a low of 1.3099 versus the dollar and continued to fall overnight, reaching 1.3087. The pound also looks to have topped out versus the single currency, falling to 1.1384 overnight.

One further negative for the pound was the inflation report which was released yesterday and undid the positivity gained from the employment data released on Tuesday. Inflation fell to 2.4%, appreciably lower than market expectations. This may be temporary as the pound’s inflation now looks to be under severe pressure and the previous days increase in wage inflation is likely to feed through into CPI.

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Defiant Fed to continue rate hikes

The minutes of the latest FOMC meeting in the U.S. were released last evening and they showed that its members are 100% behind Chairman Jerome Powell in his desire to raise short-term interest rates with one more hike this year and a continuation through 2019 and Q1 2020.

There was no reference made to the views of the President who, since the meeting, labeled the FOMC as “loco” having previously expressed his disappointment that the Central Bank saw fit to raise rates at all.

The market clearly agrees with the Fed, as the dollar rallied following the report. The dollar index reached a high of 95.66 and has remained close to that level overnight.

There seems to be little consistency in U.S. data right now with a poor read for retails sales earlier in the week, a downbeat headline non-farm payrolls and lower producer prices.

With the midterm elections now starting to take centre stage, economic data releases, other than the two most important, October employment, due for release on November 2nd immediately before the vote in November 6th and inflation, will take a back seat.

With long-term yields settling down after last week’s increases and stock markets regaining a little upward momentum, risk appetite has improved, and this should provide a tailwind for the dollar over the next week or so.

Europe’s political dilemmas continue to haunt single currency

It has almost always been believed, since the inception of the euro in 1999, that underlying political issues will eventually bring its downfall.

“One size does not fit all” and several countries will spend excessively given low-interest rates which will lead to inflation that cannot easily be controlled.

A central monetary policy, yet nineteen individually controlled fiscal policies, is never going to lead to a financial backdrop conducive to long-term success. These are the major longer-term issues that exercise longer-term investors.

The day to day movements of the euro are more often created by individual states such as Italy, with its budget deficit, or Germany, with crumbling support for Mrs. Merkel and the established order. The EU was originally formed to try to ensure that the second world war would be the last. So far, that has worked but did the “forefathers of the United States of Europe” really envisage such a need for integration?

There is an inherent flaw in the single currency that will preclude its global acceptance as a reserve currency and that is its underlying political fragility. Threats to leave (Italy) or a lack of desire to join (Poland) continue to illustrate this issue which the EU Commission and the EU Council struggle almost daily to mask.

The euro has almost become a makeweight within the G7 not sure of its global position, reacting to the ebbs and flows of the dollar index. The penchant for advance guidance by the ECB has taken the significance away from monthly data releases. As long as inflation, growth, and wages stay within their respective bands, the ECB will take no action until next Autumn at the earliest, as has been confirmed many times by ECB President Draghi.

Yesterday, the euro fell to a low of 1.1496 versus a resurgent dollar although it did manage to close just above the 1.1500 level.

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.”