23 Oct 2018: Rhetoric comes back to haunt PM

23 Oct 2018: Rhetoric comes back to haunt PM

Rhetoric comes back to haunt PM

October 23rd: Highlights

  • Nothing agreed until everything agreed creates stumbling block
  • Budget relief fails to support single currency
  • Dollar supported by rate differential

DUP support for rebel amendment hits pound

It has been a popular saying during the entire Brexit negotiation that nothing is agreed until everything is agreed. Theresa May, the UK Prime Minister, confirmed yesterday that a deal is 95% done between London and Brussels but she failed to mention any progress over the Irish Border. Mrs. May has been at pains to say that there will be no agreement that leaves Northern Ireland as part of the customs union but separates it from the rest of the UK.

Mrs. May’s words were repeated back to her today as the DUP, the Northern Irish Loyalist Unionist Party which backs her minority Government, confirmed that on Wednesday they would support an amendment to the Brexit Bill which renders the current backstop offer from Brussels illegal.

It appears that no matter what progress has been made over the divorce proceedings, there will always be this one issue that provides a degree of reality.

There is only one way there will be a hard border between the two halves of Ireland and that is if the UK departs the EU with no deal in place. The announcement from the DUP today makes that possibility more likely. The UK supports an open border, the Republic supports an open border, even Brussels supports an open border provided there are suitable customs checks performed on goods leaving the Republic for the UK.

It is still a matter for discussion whether Mrs May will survive to see the deal to its end given the groundswell of support that is apparently growing for a leadership contest within the ruling Conservative Party.

The pound broke through the psychologically important 1.3000 level versus the dollar as the news concerning the DUP broke. It traded down to a low of 1.2956 and closed at 1.2969.

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Moody’s Italy downgrade provides unlikely stability

Moody’s Ratings downgraded Italy’s sovereign debt to Baa3 on Friday, much as the market had expected following the recent release of its 2019 budget which will create a deficit of 2.4% of GDP and a probable rise in the country’s debt to GDP ratio.

Moody’s also gave Italy a stable rating which raised the markets perception of Italian debt and lowered borrowing costs. This a slight boost to the euro which has been struggling recently versus a stronger dollar.

The Moody’s report was not as bad as had been feared but the official response from Brussels to the Italian budget is still to be released. The European Council will need to choose its words carefully so as not to inflame Italian passion any further. Italy is currently embroiled in disputes with Germany over migrants and Austria over the treatment of the occupants of South Tyrol a small area of Italy’s most Northern State where there is a demand for dual nationality to be given.

While Brexit occupies most of Brussels time, it must be mindful of the goings on in Rome where the Nationalist Government has grown its powerbase even since the elections. The euro is still mostly driven by the outlook for inflation and growth and until there is some pickup which could attract the attention of the ECB, it will remain under pressure form the dollar as the interest rate differential widens.

The single currency fell to a low of 1.1455 yesterday and closed at 1.1467.

U.S. economy continues to provide wind beneath dollars’ wings

In a politically neutral environment the dollar index would be well in excess of its year’s high of 96.99 as the U.S. economy, while not exactly powering ahead, produces sufficiently strong data to allow the Fed to continue to raise rates.

When Jerome Powell was made Fed Chairman in February, it is fair to say the he was expected to be far more circumspect about monetary policy than he has been, and that has caught the market by surprise. It would seem that in his “job interview” with the President he also made that impression since Trump has clearly been taken aback by the more hawkish nature of both the press conferences and monetary policy changes that have taken place over the past two quarters.

With Q3 GDP due for release on Friday and with expectation for a far lower figure than Q2, the dollar may be in for a bumpy ride towards the end of the week particularly with the proximity of the midterm elections.

Q3 GDP is expected to be around 3.3% versus the Q2 which was continually revised higher finally reaching 4.2%. Q2 was a particularly strong period since there was an upsurge in Federal spending and the very aggressive tax cuts came into force.

The dollar index rallied today even as the euro steadied a little. It reached 96.09 and closed close to that 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.”