European Semantics

Discussion and Analysis by Charles Porter:

Tumult within the UK Cabinet developed with the overnight resignation of Secretary of State, Priti Patel. UK political uncertainty, outside of Brexit, has not, thus far, been reflected within Sterling markets. At market open this morning, the Pound appears moderately stronger, ameliorating some of the losses that yesterday’s bearish trend produced. However, with negotiations ahead, this is uncertain to hold. Overnight, the Reserve Bank of New Zealand only acknowledged strengthening global economic growth, joining a string a central banks that only foresee global, not domestic, prosperity. NZ Dollar traded 0.4% down.

Sterling Briefing: Negotiations Begin

The first round of Brexit negotiations since European Council President, Donald Tusk, announced a consensus to begin internal preparatory discussions begins today. Given that the European Council is now aspiring to second phase talks next month, there is likely to be cautious optimism priced into the Pound. The fulfilment of expectations will be imperative if Sterling is to retain its present value and begin to gain ground.

Brexit is likely to dominate both the short and the long run: the absolute trading band of the Pound is largely determined by the post-Brexit paradigm; short run trends will be determined by the success of this round. Elsewhere within the domestic political economy, Theresa May’s cabinet faces uncertain times following the resignation of both her Defence Secretary and International Development Secretary. For now, this not-so strong and stable government has not manifested into Sterling weakness.

European Semantics: 

Brexit as a phenomena may not be being priced correctly. A view that I have analysed is the ideocracy of perceiving Brexit as a zero-sum game; what one party ‘gains’ from negotiations is not taken away from the other. Either way, what is clear is that Brexit negotiations will have impacts for the Euro as well as the Pound. If Brexit is still being (incorrectly) priced as a zero-sum game at this stage, then the retention of bargaining chips is likely to be what awards the Euro with Strength.

While investors and the public alike squabble over the semantics coming from chief negotiator Michel Barnier and Secretary of State David Davis, investors will also look to the words of ECB policymakers. In light of prevalent rumors that the ECB members are far more hawkish than President Draghi suggests the views of policy makers will be particularly important. Any suggestion of a defection from the incumbent spate of dovish European monetary policy will be reflected in Euro strength.

Consolidation:

The US Dollar has gained considerable ground over the past couple of months. Shown in the adjacent graph, the US Dollar has gained almost 4% against the Euro. What goes up must come down; well, not strictly true with financial markets, however, the commitment to Dollar strength will be tested by investors in the near future.

There is scope within the Euro-Dollar cross for the trend to go either way, however, more volatile price action could well prevail.

The Days Ahead: 

Brexit negotiations will continue to dominate the FX scene, particularly for the Pound. As this continues into the week, markets will remain poised to revalue Sterling. This afternoon, US labour market data will provide clarification to the economy underlying the strong Dollar. This evening, the Banco de Mexico will decide its overnight rate, providing risk to the Mexican Peso.

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