Global Markets, Brexit and GBP, China PMI
The S&P 500 has fallen 4.2% below its August top, which seems marginal in respect of recent developments in FX markets, seeing in particular JPY and CHF rallying. It seems investors are looking for hedges instead of liquidating yielding asset holdings, and these hedges are executed in places where there is ample liquidity. Here the FX market qualifies. It seems US Presidential election fears are dominating, as illustrated by aspects of currency trading yesterday when the Fed statement confirmed our view that the Fed is heading for a December rate hike.
On a ‘normal’ day, investors may have picked up the Fed talking about rebounding inflation rates and better labour markets. Accordingly, one should not expect a strong US October labour market report due tomorrow to make any difference. In many aspects, the markets seems to be in an opposite mood to the pre-Brexit situation when investors got over-optimistic about the UK voting in favour to stay in the EU, clearing the way for a big disappointment when it became clear that this optimism was unjustified. Nowadays investors seemingly try to ‘avoid the Brexit mistake’ and prepare for a market-unfriendly outcome. There are two conclusions to draw from this observation. First, USD selling may continue into election day unless opinion polls, for whatever reason, swing back more into Clinton’s favour. Second, on November 8, markets may be best prepared for a market-unfriendly outcome. Hence, a risk-favourable election result may push USD sharply higher while options markets may converge towards lower volatility levels.
The string of better economic data releases has remained in place, with China’s Caixin October services sector PMI improving from 52.0 to 52.4 and composite PMI gaining at an even better rate from 51.4 to 52.9, reaching its highest level since 2013. Two other observations leave the impression that reflation has remained intact.First, the US yield curve has remained steep, withstanding the risk-off mood in other markets. The US 10-year yield has only declined from 1.85% to 1.80%, which seems marginal in light of current FX market volatility. Second, most industrial commodity prices have remained stable, with the exception of oil, which has broken lower due to concerns about OPEC finding it difficult to comply with its recent production cut agreement. The CRB Rind indexhas reached a new high, now trading at 469, which is 3.6% higher than the September low.
Today at 10am, the UK’s High Court will announce its verdict concerning the parliament’s voting rights in respect of triggering Article 50. The government under Theresa May denies the parliament has this right while the complainants suggest that such a right exists. In the unlikely case of the Court deciding in favour of the complainants, opening the theoretical case for parliament denying Article 50 being activated, we believe that GBP may jump by about 5%, taking it back to the level traded when the markets were pricing in a soft Brexit. In the contrarian case, GBP may ease by about 1%, bringing it back to levels where the hard Brexit fear factor was highest.