23 November 2018
Brexit: Latest breakthrough no gamechanger for ‘no deal’ risk

The leaked draft of the UK-EU political declaration sent the pound soaring on Thursday morning, but what is still not clear is if this document will help secure the critical votes Prime Minister May needs to get her deal approved by Parliament 

It’s fair to say that the draft Brexit withdrawal agreement that was announced last week hasn’t gone down too well domestically. Pro-Brexit Conservative MPs have been deeply sceptical about the possibility of the all-UK customs arrangement that forms part of the Irish backstop. While it doesn’t seem like this group of concerned MPs have the numbers so far to trigger a leadership challenge, they may well have enough backing to torpedo the deal when it is voted in Parliament.

Meanwhile, the Northern Irish Democratic Unionist Party (DUP) – whom the Conservative government relies on for its working majority in the House of Commons looks likely to reject the agreement too, citing concerns that the proposed backstop would create regulatory barriers between Northern Ireland and the British mainland.

In short, it now looks increasingly likely that the government will be defeated when the deal is presented to the House of Commons (most likely in mid-December).

ECB minutes: Glimmers of doubt

The minutes of the October meeting of the ECB’s Governing Council show some signs of doubt about the growth picture, though the ECB felt it was too soon to change its assessment. This could still happen in December though

Moderating global growth

From the minutes of the October meeting of the Governing Council, it's clear that the central bank acknowledges a moderation of global growth and some tensions in financial markets. While this was also reflected in the slightly weaker economic data for the eurozone, the overall feeling was that the news flow was still consistent with the baseline scenario of an ongoing broad-based expansion. At the same time, the Governing Council remained confident that underlying inflation would pick up on the back of higher wages and the build-up of pipeline price pressures.

Downside risks

While there was broad agreement that at present the risks to growth could still be considered to be balanced overall, a remark was made that a number of arguments pointed towards risks to the growth outlook tilting to the downside. Indeed, all members agreed that the risks related to the external environment were pointing downwards. It was recalled that the September 2018 ECB staff projections had incorporated a small acceleration in quarterly growth rates in 2019, compared with the profile for 2018, which could be revisited. The publication of the December 2018 Eurosystem staff projections would provide an occasion for a more in-depth assessment.

No change in policy guidance

While the Governing Council decided to leave the communication regarding monetary policy unchanged, there was also broad agreement that in light of still prevailing uncertainties and only gradually rising underlying inflation, it was essential to remain prudent, patient and persistent with regards to monetary policy. 

What about Italy?

Italy was mentioned only in general terms (with some tightening of monetary conditions in the country), there was no discussion on how the ECB would have to cope with a potential escalation of the situation. However, the remark was made that the maturity of some of the targeted longer-term refinancing operations would fall below one year in the course of the next year, which could impact the evolution of excess liquidity and might affect banks’ liquidity position. Given the fact that Italian banks have been amongst the main beneficiaries of the TLTROs, it is clear that a new TLTRO could mitigate some of the monetary tightening in Italy caused by the significant increase in sovereign bond yields.

Down but not out

Our take on the discussion in the Governing Council is that the assessment of the growth outlook could be somewhat more downbeat in December, without becoming outright pessimistic. Therefore, it is still unlikely that the ECB will refrain from ending its net asset purchases in December. However, we wouldn’t be surprised if December’s statement has a whiff of doubt in it, which would limit expectations of a rate hike to at most one in 2019. As for a new TLTRO, it is probably too soon to pencil it in now. A new TLTRO is only likely to be considered if the situation in Italy really deteriorates in the course of 2019.

China: Intervening in the yuan, for what?

The People's Bank of China spent CNY 91.58 billion on foreign-exchange sales in October. We believe this means the central bank wants USD/CNY to cross the 7.0 mark, but without any market hiccups

China's central bank spends second largest amount on forex sales in 2018

In October, the Chinese central bank spent CNY 91.58 billion on forex sales, which is the second largest amount in 2018. However, this was less than September, which was CNY 119.39 billion.

This data has always been eye-catching, especially during the yuan's depreciation, because it implies the central bank might have spent money in the market to stop or slow down the depreciation by selling dollars. And we don't completely rule out this possibility. 

Given the speed of the monthly yuan depreciation in October, which was 1.56%, up from 0.55% in September, we believe the central bank might have sold dollars to intervene as the speed of the depreciation indicates more intervention.

Will the central bank intervene again in the coming months?

We don't think anyone can answer this question, not even the central bank.

  • It seems the central bank is allowing the yuan to be more responsive to news, data and ad hoc information, which means the yuan is more flexible. This should imply the central bank doesn't intervene frequently.
  • But the central bank could be intervening with a target. This is more interesting because the market then wants to know what the 'target' is. Is USD/CNY at 7.0 a target or is there a line below that?

We think the central bank could be targeting small ranges that would lead USD/CNY to cross 7.0. For example, 6.91- 6.95 might be a target range for a certain period, then a weaker yuan range of 6.95 - 7.00 for later, so that eventually, USD/CNY crosses 7.0 without surprising the market. 

Therefore, we don't agree that the People's Bank of China won't allow USD/CNY to cross the 7.0 handle.

We believe USD/CNY will depreciate when trade war tension escalates, and crossing 7.0 looks increasingly likely.

The central bank is more likely to be managing market sentiment by making sure the exchange rate doesn't surprise the market. The scale of interventions will become smaller as the exchange rate approaches 7.0 so that foreign exchange reserves only fall mildly.

For now, we maintain our forecast at 7.0 by the end of this year. 

Correction: 22nd November 2018

An earlier version of this article misstated the value of the foreign-exchange sales as $91.58 billion instead of CNY 91.58 billion. This version corrects the inadvertent error.  

US: Signs of a slowdown?

The US has had a great 2018 but will face more headwinds in 2019. Worryingly, there are already some signs of a slowdown coming through in the data, in particular, the housing market 

Headwinds are intensifying

The US economy has performed really well this year with a robust jobs market and massive tax cuts helping to generate the strongest year of GDP growth since 2005. But maintaining this momentum in 2019 will be hard, given the headwinds of the lagged effects of the strong dollar and higher interest rates along with the fading support from the fiscal stimulus and intensifying trade protectionism at a time of softer global growth. Housing and investment numbers suggest that this slowdown may already be underway.

European politics in 2019: United in even more diversity

In European politics, 2017 was the year of hope for new momentum towards further integration. For a while, there was a real 'Europhoria'. In contrast, 2018 was the year of a disappointing and disillusioning return to reality (and a de facto standstill). Will this disappointment reach a climax in 2019 or could we see another turnaround?

Leaving Italy’s fiscal escapades aside, three main political themes should get financial markets’ attention next year: elections for the European Parliament in May (held every five years), a changing of the guard in European top jobs, and German politics. Let’s try to put these three potential risks into perspective.

Switzerland: ‘Self-determination’ vote may have major impact on markets

A referendum in Switzerland on Sunday could complicate current negotiations with the EU and the economic and financial consequences could be significant

Referendum on 'self-determination'

Switzerland goes to the polls this Sunday to decide whether Swiss law should take precedence over international treaties. Supporters of the initiative, which was launched by the country's biggest party, the ultra-conservative and eurosceptic Swiss People's Party (SVP or UDC), say global agreements should be renegotiated or cancelled if they clash with the results of a domestic referendum. 

The vote is a consequence of a previous referendum on immigration almost five years ago when a majority of Swiss citizens voted against mass immigration and asked for the introduction of immigration quotas. Such quotas would have been in direct opposition to the international treaties that existed between Switzerland and the European Union. And so after long discussions, and contrary to what was required by the Constitution, the initiative never became law. Instead, the government pushed through regulations giving priority to Swiss-based workers in certain sectors of the economy with the highest unemployment rates.

The SVP argues that the Swiss Constitution, which normally requires parliament to turn referendum results into law, has been overruled by international law, and it wants to stop this from happening again.

Poland: Bank supervision scandal and its impact on markets

A recent alleged supervision scandal in Poland will probably mean that the zloty underperforms regional currencies in the short term. The majority of first-round effects negatively affecting Polish government bonds are probably behind us. Some second-round effects are unpredictable, especially in the political sphere

The head of the Financial Supervision Authority (KNF), Marek Chrzanowski, resigned last week following allegations of corruption. Media reports claim Chrzanowski demanded money from Leszek Czarnecki, the main shareholder in two small banks facing liquidity, credit quality and mis-selling issues, to prevent them from defaulting or being forced into a takeover by other financial institutions. The Polish zloty (PLN) and local government bonds (POLGBs) underperformed Central and Eastern Europe (CEE) FX by about 1%, which we believe was a response to this unfolding story. Chrzanowski has denied the claims.

Eurozone: a dismal third quarter confirmed

GDP growth in the Eurozone was confirmed at just 0.2% in Q3. Industrial production saw a decline in September. While a small recovery of GDP is expected for Q4, growth momentum has clearly been lost in 2018

The second estimate, GDP growth was confirmed at just 0.2% QoQ and 1.7% YoY. The main culprit was Germany, the Eurozone’s stronghold throughout the 2010s, which saw its economy shrink by -0.2% in Q3. Disruptions in the car industry were an important driver of the first negative quarter since 2015 and the slow quarter in the Eurozone, but it seems that the worries about growth are broader than that.

Exports are weaker thanks to global problems related to trade wars and emerging markets, and consumption was dampened by the higher oil prices seen in Q3. The stagnation in Italy’s economy adds to worries around the Italian budget. The confrontation with Brussels has not been resolved as the ball now returns to the European Commission’s court that now has to decide whether to put Italy in an excessive deficit procedure.

Industrial production in the Eurozone posted a very small decline in Q3, adding to the slow growth performance. Production in September dropped by -0.3% MoM. On the year, growth is just 0.9% for industry and production is still well below the November peak. 2018, therefore, seems to have become the year of one-off excuses for a severe weakening of growth. The question is whether this explains the whole picture or whether these are excuses along the lines of “the dog ate my GDP” and something more structural is happening. While a small recovery of growth in Q4 is in the making, it seems evident that the growth cycle for the Eurozone already peaked last year.

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In case you missed it: Rethinking rates

The global economic backdrop is looking murkier by the day. In the US, intensifying headwinds have prompted a rethink on the Fed's aggressive hiking plans while in Europe, weak data and seemingly endless political uncertainty have raised questions about the ECB's next move. And things are no less complicated in Asia...   

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