FX: The pound is stuck in a delay dilemma

The USD recovered some losses yesterday thanks to markets scaling back Brexit optimism. However, any further rebound in the greenback is likely to be challenged by the increasingly solid expectations of a Fed cut next week (which is also our view) and the still optimistic newsflow when it comes to trade negotiations with China. Elsewhere, the rest of this week will be dominated by a slew of central bank announcements in Europe, with the ECB, Swedish Riksbank and Norges Bank all meeting tomorrow. For today, the USD may capitalise on good momentum to extend gains on further sliding global sentiment.

The EUR kept piggybacking on the pound in yesterday’s price action around the UK parliamentary vote and may continue to do so in the coming days. Ahead of tomorrow’s ECB meeting, that is expected to carry a limited surprise potential, 1.1135 (100-d MA) may prove a fairly solid resistance for EUR/USD.

Once again, a session in the UK Parliament yields more questions than answers. MPs gave initial consent to the Brexit Withdrawal Agreement Bill (with a solid 30-vote margin), but the PM’s proposed fast-track timetable was rejected. Johnson announced he will pause legislation on the deal whilst waiting for the EU27 decision on the Article 50 extension. The result was a drop in sterling as the prospect of another delay dented investor optimism for a quick resolution and likely increased the perceived risk of snap elections.

At this stage, many options remain on the table. Johnson would ideally like a short-extension (a couple of weeks) to keep pressure on the House, but the EU may be little inclined to take such risk and will likely deliver a longer extension (possibly until Jan 2020). Once the length of the delay is set, Johnson will decide whether to try and go straight to elections – although it’s not clear Parliament will let him do this right now. Alternatively, he could press ahead with the legislation, where the next step would be for MPs to put forward amendments.

Looking at the FX-impact, the current situation suggests that: (a) more uncertainty is being priced back into GBP; (b) the downside for GBP still seems quite limited given that Johnson now appears to have a majority to back his deal. In turn, the pound may drop some of the recent high volatility and get stuck in a “wait-and-see”, relatively tighter band, possibly hovering around the 1.28-1.29 area vs the USD.

EM local currency bond indices are performing well this month as investors focus on the external positives. EM high yield FX, in particular, has done well as investors chase local bond stories on hopes of aggressive easing cycles in the likes of Russia, Brazil and Mexico. Key event risks in South Africa, including the budget statement on 30 October and Moody’s ratings decision on 1 November, however, mean that the SARB is cautious about cutting and that the immediate upside for SAGBs may not be as large as that for some other high yielders. That said, any downside surprises in South African Sep CPI today would probably be seen as a net ZAR positive and could help USD/ZAR towards the 14.45 area.