27 September 2019: Sterling falls as reality bites

Sterling falls as reality bites

September 27th: Highlights

  • Even if Brexit is extended, what happens in January?
  • Dollar retains gains by default
  • Euro to test long term support

Uncertainty driving Sterling lower

If the premise that Brexit is going to happen remains, the market must come to terms with what the economic effect on the currency will be.

It has been almost a year since the Withdrawal Agreement that was to be so savaged by Parliament was agreed between London and Brussels. Since that time, the spectre of a no-deal Brexit has been overwhelming to the market. With the Opposition Parties holding sway over Parliament they are trying to remove any chance of a no-deal Brexit before agreeing to a General Election.

The next few weeks will determine the medium to long-term outlook for the economy as the electioneering begins. The Government will want to make the election all about Brexit with their strategy being based almost entirely upon the fact that they are the only major Party 100% committed to the UK leaving the European Union.

Of the two major opposition parties, one is firmly determined to cancel Brexit in the highly unlikely (some would say impossible) event they win the election, while the other has decided to sit on the fence despite an incredibly close vote at its Party conference to support remain in any referendum or election.

It would be foolhardy, after the result of 2017, to predict an election result other than to say it will be close.

It is entirely likely that there could be another hung Parliament with the ruling Conservative Party gaining the most seats but not enough to form a Government on their own even with the support of Northern Irish Unionists. That means another coalition which would bring the right-wind Brexit Party to the fore. With Labour most likely coming down on the side of remain in that event, it would be the Liberal Democrats versus the Conservatives and Brexit.

The Liberal Democrats have already affirmed they will not enter a coalition but seduced by the idea of a remain-supporting alliance with Labour, they could easily be persuaded as the election looms.

The uncertainty that the political landscape has brought about is leading to a longer-term deterioration of both the economy and the economy.

Yesterday the pound fell to its lowest level for two weeks despite no-deal being as close to being off the table as it could be. This could be a sign of the market’s faith beginning to fail. It reached a low of 1.2302 versus an admittedly stronger dollar, closing at 1.2323. It remains supported versus a weakening single currency but is not making any significant headway.

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Greenback remains the market’s go-to refuge

In times of global uncertainty, it is the currencies that either have the largest surpluses like Japan and Switzerland that fare best and the dollar. The dollar’s safe-haven status is something of an enigma. Often the global crises which lead to economic downturns are precipitated by the U.S. but its currency benefits due to its infinite liquidity and convertibility.

While there is no discernible crisis immediately on the horizon, the possibility that either Beijing or Washington could lose patience with the other could bring about an all-out trade war which would lead to a considerable downturn to global activity and, growth. Current estimates that an all-out trade war could wipe up to 2% off global GDP sending some developed, and most of the emerging markets into recession.

The fear of the pending impeachment of President Trump appears to be somewhat overblown at present particularly as Congress would need around 20 Republicans to support the Bill and that is unlikely at present.

It is hard to gauge the exact intent of the Fed following its monetary policy changes at the past two FOMC meetings. The markets are prepared to take at face value, for now, the inference that both rate cuts were simply insurance against a more prolonged downturn in economic activity. The Dow remains within touching distance of its all-time high so there is little concern over the economy being seen in the equity markets.

While such issues can “turn on a dime” it would seem that the next major events in the U.S. will be the preparations for the 2020 election and the only questions left to be answered “who will run against Trump and can he/she win?”

Yesterday, the dollar index remained well supported reaching a high of 99.28 and closing at 99.19. That was its first close above 99 since May 2017.

Markets finally losing faith in the euro

A couple of weeks ago, I mentioned the possibility of the single currency testing its medium-term target of 1.0840.

The price action since then has been choppy mostly due to the hedging of traders’ positions in the dollar index. The euro itself has entered what looks to be a longer-term downturn. This is likely to be punctuated by a few reversals as the dollar reacts to global events but overall, the 1.0840 support is now firmly in the market’s sights.

Traders have lost patience with what had been a growing belief that the economy had reached its floor and, while no rapid recovery was envisaged further dramatic falls were expected.

That “playbook” was firmly ripped up over the past few trading days as German activity and economic expectations data both fell to unprecedented levels.

The European Central Bank is now powerless to arrest the slide into recession and has reverted to an entirely defensive position designed to make the contraction as short as possible although that is seemingly out of its control.

The release of GDP data for both Germany (as the bellwether of Eurozone economic activity) and the wider region is likely to confirm a technical recession.

The technical definition is for a country (or region) to have two consecutive quarters of negative growth. Having contracted by 0.1% in Q2 it would be quite a stretch to expect anything other than a further contraction in Q3, given the data that has been released.

There are several analysts and commentators looking for the euro to trade at parity versus the dollar this year but there are several major support levels to be breached before than can be seriously considered.
Yesterday, the euro fell to a low of 1.0908 and closed at 1.0921.

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.”