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Morning Brief – Top Trumps

Top Trumps

 

As eagle eyed purveyors of the foreign exchange market I’m sure each of you reading this would have been keeping a watchful eye over the actions of the Federal Reserve Bank in the United States and UK inflation yesterday. In fact, both events seem like they might go down as the two most important events of 2019 not to have (yet) moved the foreign exchange market. 

 

 

UK Inflation

 

Since the referendum in 2016 wiped out up to 15% of the value of the Pound versus its major peers, inflation has held firm. As a consequence of the United Kingdom importing a high proportion of its consumables and goods in from abroad, the weaker Pound immediately pushed import prices higher, raising the general price level. Due to the economic rule that higher inflation rates are normally signalling stronger economic activity, the Bank of England was able to perform a juggling act presenting above-target inflation as a symptom of a robust domestic economy, not a struggling one.

 

The three years since the referendum have therefore seen the Bank of England play an accidental role as the defender of the value of the Pound. Whilst politics and global economics might not have been on its side, the role of our central bank in promising higher yields behind the Pound when the rest of the world’s central banks were easing policies saw it claw back and protect the value of GBP. However, the truth behind domestic inflation, particularly within more homeward orientated markets that seldom compete overseas, has been one of relative stagnation. Within importation markets we always see lags whilst reserves are depleted and statistics sort themselves out. Across the world, for example, we measure inflation in year-on-year terms so the observed inflation rate is the price change versus twelve months ago.

 

A systemically higher inflation rate caused by rapidly inflating import prices is gradually eroded by this year-on-year observation method; higher prices today compared with similarly high prices one year ago in percentage change terms do not show up. Yesterday’s inflation reading of only 1.7%, the lowest since 2016, will worry markets that inflation will continue to fall now that the statistical obscurity has worn out. All this means that the Bank of England, through its use of sanguine language, may not be able to be the defender of the value of the Pound, opening the path for it to move lower if political (read Brexit) developments do not play out in its favour. Yesterday the Pound fell but only minutely reflecting investors’ preoccupation with Brexit and all things politics.

 

Today the Bank of England will deliver its September policy decision. They are unlikely to follow the US in cutting rates given the one off nature of this data, however, their language will be studied to gauge expectation surrounding future price movements. 

 

 

FED

 

The Federal Reserve Bank in the United States cut interest rates but 25 basis points, 0.25%, yesterday evening. With the president’s scathing reaction to the decision, the broadcast of the Fed meeting could rather have been on Comedy Central under the programming of “The Roast of Jay Powell”. But there’s always a certain joy in watching a central banker explain that all is rosy, couldn’t be better, but we’ve got to cut interest rates once again in a consecutive meeting. 

 

A hawkish press meeting following the cut decision pushed the US Dollar higher but only marginally, keeping USD within its week-to-date range. The limited price action reflects investors’ distrust in the banking authority but also their distaste to enter alternative currencies and assets – it’s still the best of a bad bunch. However, with the lion’s share of foreign exchange traded in the City of London, more US Dollars are traded in London than in New York. My suspicion is that traders in Europe are unlikely to be impressed by last night’s decision and so steer on the side of caution with respect to Dollar holdings. 

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Crude Responses: Oil and Brexit

Crude Responses: Oil and Brexit

 

The attacks over the weekend on Saudi Aramco’s eastern facilities have moved foreign exchange markets. Unlike a lot of financial headlines at the moment, this serious threat to the provision of global energy looks as though it could have an enduring impact upon global FX. Throughout yesterday’s European trading session, a demand for security led to a defensive bid for the US Dollar. For decades, the relationship between the value of the US Dollar and the price of oil has been inverted: the higher the cost of energy (usually denominated in USD for additional statistical complication) the weaker the US Dollar would likely be.

 

Given that Brent Crude (BRN), for example, could be written as an exchange rate between the commodity and the US Dollar in the form of a currency pair, BRNUSD, comparison is challenging. A move in the price of a Dollar de facto changes the analysis of the relative value of a barrel of oil versus a unit of currency and vice versa. However, take my word for it, the relationship is one of the tried and tested gospels of the foreign exchange market.

 

In recent years it has become widely recognised that the United States is largely energy sufficient and within certain studies is even proven to be a net exporter of oil. West Texas Intermediate, a widely adopted bench mark, represents oil largely which consists of that extracted from the Permian Basin in North America. Having been explored for around a century now, this oil field was unable to provide for the vast oil and energy demands of the world’s most significant developed economy. However, the invention and liberalisation of alternative energies exploration including fracking and shale production have changed the scene. The strong-oil-weak-dollar relationship is almost as significant in some market veterans’ eyes as the law of gravity and a challenge to it has the potential to upset many traditional flows.

 

Yesterday, as stated above, the Dollar appreciated by around one quarter of one percent (25 basis points) across the board. If the 5.7 million barrels per day of crude oil that have been withdrawn from daily production as a result of the attacks on the Saudi Arabian plant take several weeks to be restored, $100pbl is seriously possible. Given the United States’ relative insulation from this energy crisis and slight positioning towards energy exportation, we could rationally expect the Dollar to continue its advance.

 

On the other side of the energy crisis, those economies highly dependent upon oil and energy importation have had their currencies severely weakened by the forces within the global foreign exchange market. Turkey and India are particularly vulnerable to energy prices with almost total exposure to foreign energy resources. With worryingly high structural current account deficits, the worsening terms of trade (the relative cost of economic activity and production at home versus abroad), both currencies suffered yesterday.

 

At market open on Saturday evening, the price of Gold in Dollar terms gapped up and opened above $1500 per ounce, to record an immediate change in price of 1.5%. The Indian Rupee opened 1% down on its price versus its Friday close against the US Dollar and the Turkish Lira traded down by 1% against the Dollar before the European session began.

 

The other crude response came in the form of Brexit. The Pound threatened to continue its surge at lunchtime yesterday when optimistic reports regarding the lunch time meeting between UK PM Boris Johnson and EU Commission President Jean-Claude Junker surfaced. However, when the request to move a press conference between Johnson and the Luxembourg Prime Minister inside was rejected, Boris’ refusal to take the stand left Pound traders concerned. The value of the Pound fell once again to close 0.5% down against an appreciating US Dollar and 20 basis points down on a trade weighted basis. A lack of progress and workable solutions to the Irish backstop continue to hamper the Pound. Despite the short squeeze that led to last week’s rapid appreciation of the Pound Sterling, short positions as recorded by CFTC data showed the volume bets that would profit from GBP heading downward reach a two year high. This positioning leaves the door open for a sharp correction to the undervaluation of the Pound but is also a perfect indicator for the uncertainty and fragility within the UK economy.

 

 

 

Discussion and Analysis by Charles Porter

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UK buildings

Morning Brief – How much?!

How much?!

 

Outside my window in Johannesburg there is an electronic billboard that, when not tempting me with the nation’s latest trendy tipple, displays an advert claiming South Africa’s best savings rate. On a 60-month fixed term the investment promises returns in excess of 13%. I haven’t been fortunate enough to catch the fine print written obscurely at the bottom but, with compound interest over a 5 year period it’s reasonable to assume this is an average annual return perhaps with a slither of dodgy accounting practice. Before you send money flying over to take advantage of this interest, remember: with great power comes great responsibility! By the way, I was more enthusiastic about this quotation before I googled it and found it’d been lodged in my memory by Spider-Man… 

 

 

Mastermind rules:

 

I’ve started so I’ll finish. The great power behind savings and yield accumulation in South Africa has a corollary: an overwhelming responsibility to repay debt with interest (including interest upon interest ad infinitum) appropriate to the borrowing rate in the economy. As is often the case in developing markets, the latter responsibility is not upheld, creating a lack of demand for the former (deposit) side resulting in a shallow and unbalanced domestic debt market. Sub-Saharan Africa’s most significant economy this morning has captured international financial headlines as it does battle with this issue.

 

A report from a company called Differential Capital has warned today that 40% of domestic borrowers in South Africa are in default, leaving millions of people in a debt trap. The money borrowed amounts to a collective 225 billion Rand across 7.8 million people (in SA’s 60-million strong population). The debt (just shy of R29,000/capita) is dangerous given that it is un-collateralised. Allowances for these unsecured loans were increased in 2007 to boost domestic activity in a time of global turndown. However, with debt centre stage as South Africa remains at the mercy of Moody’s credit rating advice, the accumulation of debt has the potential to wreak havoc.

 

 

Time-Bomb

 

Yesterday, South Africa’s daily business newspaper proudly claimed that Moody’s had confirmed it won’t downgrade its debt from its present rating of Baa3, the final rating before the asset becomes classed as junk. Good effort, but that’s not exactly what they said! Poetic licence translated the statement that it’s unusual for the agency to downgrade debt a whole rung on the ladder without first giving it a negative outlook (that it doesn’t presently have) into the certainty of maintaining investment grade for a year to a year and a half (maths made up according to South Africa’s bi-annual debt review schedule).

 

However, particularly in light of the issues with domestic unsecured debt making headlines this morning, South Africa does stand at a precipice with the potential for financial turmoil and, unsurprisingly, currency turmoil. The market knows it already. Credit default swaps (as mentioned in this briefing before and by Margot Robbie in a bathtub) are a way of pricing the risk of a financial instrument and helpfully allow us to rank the market-perceived credit worthiness of each nation.

 

In South Africa the insurance against default on sovereign debt over a five year time horizon is twice as expensive as it is regarding Brazilian sovereign debt, a nation which is rated as Junk already (two whole steps behind South Africa). The market is screaming warning signs and it is inhibiting the Rand. The confirmation of Junk status by Moody’s in the coming months (heads up for its first ratings decision this year anticipated on 1st November) will see the Rand tumble below the levels that debt markets currently price the nation.

 

If that all wasn’t enough, today the European Central Bank will deliver their monetary policy decision. Markets are pricing in rate cuts and anticipate the reintroduction of Outright Monetary Transaction spending plans and strong forward guidance. The event should mark a period of heightened volatility and, as ever, bargains will be on offer when markets function more erratically. The salience of this decision has been heightened even further by a dispute yesterday from Dutch authorities over the nature of tiered interest rates.

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Volfefe

Volfefe

 

The President of the United States of America needn’t exercise all of his 280-character quota (including spaces) to upset financial markets. In fact deploying the full arsenal of a tweet might be too crass for the reserved and presidential billionaire. However, his contentious Twitter account “@realDonaldTrump” moves interest rate; currency and equity markets all to often. In times when the early hour musings of the president can send a currency, it’s stocks and related interest rate instruments tumbling you want to do something to get on top of it.

 

 

Introducing: Volfefe

 

Remember that ill-fated tweet by the President containing the word “covfefe?!”. Still don’t have a clue what he meant? Well, in the absence of clarification or explanation you’re not the only one. As one of the more iconic and less market shaking tweets since he took office, the made up word now forms the basis of a new J.P. Morgan Instrument to measure and track the volatility in (fixed income) markets in reaction to #DJTrump. The study finds that Trump’s tweet regarding the enduring strength of the US Dollar has the strongest effect upon currency markets, trigging a defensive bid for the Japanese Yen and demand for perhaps its greatest substitute, the Euro.

 

A shaky day in British Politics led to a sharp 1.2 cent gain in the value of one Pound Sterling in US Dollar terms. At market open, the reaction to persistent GBP strength last week saw the value of the Pound track unconvincingly downwards as Europe settled following the weekend. Despite limited successes at a meeting in Dublin with Irish Prime Minister, Leo Varadkar, GBP trudged higher. UK PM Johnson’s counterpart and tricky member of the European Council kept hopes of a breakthrough in Brexit negotiations suppressed. The heated meeting comprised of exchanges over the possibility of direct rule by the UK government and Parliament over Northern Ireland.

 

A leaked memo increased tensions regarding the Norther Irish Border problem because it suggested political immobility in Northern Ireland would mean Britain would have to take back control of devolved powers. Stormont has been suspended for more than two years leaving the administrative body incapable of making the rapid and salient issues that  would necessarily arise from a hard Brexit. 

 

With the bill aimed at preventing a no-deal exit having gained royal ascent yesterday afternoon, Sterling rose higher. It was perceived as impossible that the bill would fail following the ratification of the House of Lords last week and Sterling’s powerful rise yesterday was likely a reflection of stronger risk sentiment as opposed to political resolve. USDJPY rallied to claim a healthy 107 handle as defensive holdings of the safehaven Japanese Yen were unwound. The UK Parliament is now officially suspended until October 14th, three days ahead of a pivotal EU summit and less than three weeks from the date that Number 10 still claims will be the do or die Brexit day. 

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Mirror, Mirror on the Wall

Mirror, Mirror on the Wall

 

Headlines in newspapers and on television screens have been captured by two phenomena in recent weeks. They’ve scrambled to simultaneously grapple with the chaos unfolding within the UK’s exit from the European Union and the protests in Hong Kong. Yesterday, both took a huge leap. The direction of that leap, particularly in the UK’s case, is as yet to be decided.

 

 

Snow White

 

So there you have it, Corbyn has officially called himself a Disney Princess. Comparing Johnson’s offer of a general election to the extension of a poison Apple by the wicked queen, the Member of Parliament for Islington North implied he’s Snow White. Watching the well-rehearsed bickering in the Commons yesterday I’m sure the squabbling pair might find themselves more akin to the ugly sisters in Cinderella. Just a thought for your next PMQs Jezza.

 

Following a hectic Prime Minister’s Questions at midday yesterday, Chancellor Sajid Javid presented his latest spending plan promising an already forgotten spending revamp. After his maiden spending plan, debate began on the rebels’ bill that seeks to force the UK to pursue a Brexit extension. Sorry Sajid, but if your speech is straddled by an address to the house by someone who’s calmly sacked 21 of his own party and a debate by those very MPs on the path of Brexit, no one’s going to pay a great deal of attention to you. Still, it takes guts to announce a “decade of renewal” as the ground you stand upon starts to crumble. Only hours later, the PM would (fail to) push for a general election. 

 

The bill passed 327 votes to 299 and before anyone gets handy with a calculator, yes, yes that is 52:48; a ratio that seems to be more pertinent to the UK than Fibonacci, five a day or 9-5. As promised by the UK leader, the bill passing the Commons yet again led him to trigger a debate on holding a general election. Unfortunately for him, the abstinence of the Labour Party meant that Johnson was embarrassed, failing to reach even close to the 434 votes needed to push for a public vote. 

 

In normal times general elections upset the value of a currency. They introduce an element of risk because you can never quite be sure what the public will do, cf. Brexit. However, with Johnson barrelling towards a no-deal, a perceived disaster for the Pound, the possibility of a change of administration creates the risk that an alternative government could come in and perhaps it wouldn’t run headfirst, blinkers on, over a Brexit cliff. The threat of an alternative forces Sterling bears, those who have bet on its demise, to buy protection and consequently buy the Pound. That’s what dragged the Pound up so much over the past two trading days. However, taking a position on the Pound still needs to be conditioned on the Royal ascent of the extension bill and then Labour’s willingness to contest an election. 

 

 

Bleating Lam

 

Hong Kong’s executive Carrie Lam has withdrawn the extradition bill that began the now months-old protests on the streets of the Chinese special administrative region. Some activists are saying it’s not enough; they want more, this small step has taken too long. However, despite their persistence, markets seem pretty convinced the withdrawal is meaningful to the path of its political economy. Whilst the USDHKD peg did not break on a spot value, the forward curve had some interesting action that saw it change direction and, on longer durations, break through the upper 7.85 bound. The spot value of the currency did well yesterday upon the news, appreciating by half a Hong Kong cent versus the US Dollar. But the forward curve is where the party really was. Instead of offering a discount on a contract to exchange USD into HKD as a point in time further in the future than two days, the market reverted to favour the Hong Kong Dollar on long duration trades. The price flip represents the restoration of confidence in Hong Kong and its currency, pricing out the risks that the riots confronted the economy with.

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Is this a test?

Is this a test?

 

2016; 2017; 2019. These three years have now all seen cable (nickname for currency pair GBPUSD) test its post-referendum low. Building a hyper price-sensitive area around the 1.20 mark, the pair has flirted with this low five times in these three years. This time, the direct risks levied against the Pound with BoJo in power are bigger than the uncertainty risks present in the two years after the referendum (2016; 2017). But the question for the mother of all Pound trades will be “are the risks on balance large enough to force the pair to break its 4-times reinforced resistance?” You need to decide for yourself the balance of risks but this brief will guide you through how to categorise them. 

 

Block the previous threats to GBPUSD’s post millennium low into three different categories of uncertainty: 1) Known Knowns; 2) Known Unknowns; 3) Unknown Unknowns. Now, read this too many times and you’ll be scratching your head and asking a colleague, neighbour or friend whether the word Known is starting to look odd to them. But bear with and read the above as follows 1) I know what the problem is and I know what’s going to happen; 2) I know that I don’t know what’s going to happen; 3) I’m unaware of something I don’t know about. Now 3s, the unknown unknowns, aren’t an exercise of ignorance but rather are your unintended consequences or freak incidents. An investor will have perceived the risk of all three of these uncertainties and used this information to inform their decision to either buy and hold the Pound or sell it and attempt to profit from its demise. 

 

In 2016, we had a scenario populated by unknown unknowns; Article 50 had not been triggered, we didn’t really know what to worry about: elections; negotiations; referenda. We were aware of the issues and destination but remained (not so) blissfully unaware of how we might get there, the issues that would arise along the way and what we’d find once we arrived. So, the Pound sold off in an endeavour to price in the fear that things could go wrong. Put differently, the uncertain prospective holder of the Pound demanded a premium to sell it to you. Within that premium, an arbitrary probability to account for the many unknown unknowns, about scenarios we feared we may one day fear, demanded that self-preservation dictate we don’t hold the Pound. It therefore falls but, crucially, found bedrock around the 1.20 level.

 

2019 is a different kettle of fish: Article 50 has been invoked and has held for well over two years. We have a Prime Minister that tells us we will leave on the 31st October because he will not be requesting an extension from the EU under any circumstances. With the change of leadership and in this currency slide, the nature of threats are overwhelmingly more known. Even risks to the divorce deal are overwhelmingly known. So to analyse whether the pair will break this historic level you should ask yourself this: is the state of play as we can easily read it today worse than the panic sell offs in 2016/2017. If yes, then your conviction would be that the pair should head straight to jail, do not pass go, do not collect £200. However, particularly given the risks in parliament today that might force Johnson’s hand towards a general election, if you think things aren’t as bad as they could have been, you favour a fifth bounce off of this level and a rally higher for the Pound. 

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Overreaction

Overreaction
 

Yesterday saw the implied probabilities of a no deal exit from the European Union rise within betting and foreign exchange markets. The source of the threat stemmed from Boris’ approved request to Her Majesty to prorogue Parliament. Translation: make lawmakers come back to work later than planned to prevent legislation legally blocking a no-deal exit from the EU from being created and passed. 

 

A flight to safety saw money rush out of the Pound and into more defensive assets. Treasury yields in the UK fell once again as perceived economic risks mounted, increasing the market value of holding low reward but heavily defended money. The Pound lost around 0.7% at worst on a trade weighted basis and up to 1% against a rising US Dollar. Overreaction? No! Not even a little bit. 

 

The overreaction came on Tuesday. Pro-remain MPs, some 200 strong, have signed a promise to sit and contest the government on any course that would target a no-deal exit on 31st October. Upon the suggestion of either passing legislation to demand the government to seek an extension from the EU or setting up a rival parliament to undermine the government, Sterling rose some 0.5%. Overreaction? Yes! 

 

If you look in terms of pure value the Pound’s reaction over the two days should tell us that 200 MPs signing a letter is half as important as granted permission from the Sovereign to forbid Parliament from stopping a no-deal. Let’s put that impact into numbers to quantify the impact. There’s about 2.9 trillion quid in the UK system, that’s the amount of money in existence using a fairly middle of the road measure of the breadth of money called “M3”. So, Tuesday’s news of opposition to a no-deal added about 14.5 billion to the value of that money and yesterday’s no-deal development, even certainty as some yesterday said, added 29 billion onto that value. 

 

The relative impact in markets of both events is staggering given the fact that 200 MPs is less than even the Labour Party alone have in the House of Commons. To set up a rival Parliament 2/3s of MPs would have to defy order, equal to 434 of them! So what Tuesday really showed is that Parliament has less than 50% of the number of people required to do anything about Boris’ no-deal push! Wednesday delivered something real, something certain, that will, negotiations and backstop permitting, force the UK out of the Union on Halloween with WTO standards and an alien status with respect to the Union. Yesterday may well have been worth losing 29 billion from the value of UK money but Tuesday isn’t worth a penny on that!

 

So why?! Well, market reporting and positioning data shows us that for every market participant long of GBP (betting that it will increase in value), there are 3 others that think it will go down and have put their money on it. Think about it: Every time the price goes down and your bet gains in value why would you do anything? You wouldn’t! You take the appreciation and have no incentive to change your position in the market so there’s limited market action and therefore little price action. However, when things start to look up and you’re going to pay for that improvement hand over fist you do something about it: you get the hell out! You buy back the instrument you’ve bet will do down and thereby add to the aggregate demand for Sterling to protect yourself from losing any profit gained and potential losses. The lesson to take away is that good news will sell from now on – it has the potential, given market positioning, to rally the Pound well above its post-Brexit range. Bad news, no-deal rumours and developments will only marginally force Sterling to sell off. Watch out then for any change in tone from Johnson not surrounding the prorogation but in Brussels. Amidst the whirlwind Johnson is creating we’ve missed that he’s only after a removal of the backstop from May’s withdrawal agreement that had the support of the European Council (admittedly not Parliament). Boris’ government is happy to the withdrawal bill (which for the record is far less than the value the Pound lost versus its peers overall yesterday) and it’s okay with the 599 pages of the document besides that. Watch Brussels, watch Ireland and watch Downing Street for any sign the backstop could go because the Pound will fly. 

 

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Tuesday 27th

Summer Turkey

 

An escalation of the trade war in the first half of the fine August Bank holiday weekend gave way to calmer headlines and reprieve at the G-7 in France. Plainer sailing has greeted markets so far this morning with major pairs priced relatively in line with their Friday close. However, there were a couple of ships capsized in the chaos of the weekend.

 

The leader of the free world took to Twitter and showed us rather unequivocally how he felt about Sino-US Commerce:

 

“Our great American companies are hereby ordered to immediately start looking for an alternative to China…”

 

Sure, a presidential decree doesn’t have a great deal of bite when delivered from some celebrity’s personal twitter account. But the former US Apprentice star is swift with regulation and his propensity to put something on official paper accompanied by that god-awful felt tip pen scribble that he calls a signature should not be underestimated. It’s this fear that leads investors to react violently to any of Trump’s tweets that threaten stability and international order. The same thing happened this weekend and there’s three important things you need to know to make sense of today’s market: 1) the defence 2) the Lira and 3) the trend.

 

The defence: in immediate reaction to Trump’s tweet and the rhetoric of his inner-staff equities sold off like they were going out of fashion. An immediate 2% drop in the value of equity futures contracts confirmed traders’ concerns surrounding an escalation of the trade war. The defensive move favoured US treasuries which caused yields to fall to only an inch away from their record low during the Brexit referendum. The falling yield didn’t undermine the US Dollar this weekend and into the Monday open given its status as the underwriter of international trade and a safehaven in its own right. The most popular defensive currency trade was to buy the Japanese Yen in a flight to safety. USDJPY crossed through 1.05 once again. But the most interesting event was the flight from risk not to safety.

 

The lira: Turkey’s currency has had a torrid time over the past couple of years. Erdogan’s leadership has long been a target of Trumps twitter rage and investors too have been concerned about the economy and its politics and consequently its currency. This weekend the move in the Japanese Yen and flight from risk led holders of the Lira to dump it, creating yet another flash crash for the currency. The Lira came back gradually from its crash but the move confirms that the Lira is one of the pariahs of the foreign exchange market. The ability for a risk off move to create a flash crash shows us how little confidence investors have in the currency and gives us the expectation that it could continue to be fragile in the coming months – it’s always first in line to be dumped. The price of the Lira versus the Dollar declined by 12% during the market singularity. But that won’t help you if you’re not involved in the Lira.

 

The Trend: now this can help you navigate the rest of the trade war. Whilst market reaction was significant to the rise in tension the fall out was once again less significant than that witnessed after previous episodes. Average volatility is declining each time the trade war comes into focus meaning that price action surrounding battles in the trade war is less severe each time. Now we could say that’s just natural; a threat to trade is already priced in so when it rears its head again less happens. But it doesn’t look like that’s the case. A tariff is a direct threat to trade and, if anything, the rising volume of goods penalised by the sanctions has a compounded effect on global growth expectations so, if anything, each battle should see volatility more severe than the last event. Instead we can argue then that the market is caring less about the trade war and we could expect a smoother ride moving forward.

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Thursday 22nd

Brussels Sprouts Little

 

Sure, Johnson met Merkel in Berlin yesterday but you try and make a pun suggesting political frustration and Germany’s capital city! Suggestions welcome! Now, in the real world this week, Sterling has been pushed higher (Monday), dragged lower (Tuesday and Wednesday) on whims of reports of progress and then frustration on the European front. When Merkel initially hinted towards potential progress despite Johnson’s hardline Brexit stance the Pound picked up 0.5%. But as it became clear that face to face meetings would still result in nothing this week the Pound slid once again, giving back the majority of its Monday gains to its peers.

 

France’s President Macron has suggested that his base case for Brexit in now a no-deal. That’s not really surprising: Since becoming a member of the European Council Emmanuel Macron, a staunchly pro-integration French politician, has pushed towards unity in Europe. So any state, individual or movement attempting to undermine his efforts for integration is always met with contempt. As Johnson meets Macron in Paris today, we’d be wise to remember the Frenchman’s Europhilic persuasion.

 

Other member states have remained on the sidelines when commenting on the UK’s new Prime Minister and recent Brexit developments. I suppose that’s unsurprising in Italy, where President Sergio Mattarella attempts to pick up the pieces of his country’s broke coalition. As his efforts continue to try and piece together a governing body capable of respecting the EU’s budgetary requirements, you won’t have seen this many pieces inserted in the wrong places since that infamous episode of the inbetweeners. Italian risk has weighed on the Euro, compounding with German economic risk to produce an EURUSD just pips off of its August lows which, for the record, are equal to 18-month lows on this pair. Optimism has been found at market open this morning from French and German PMIs that show optimism in the German economy.

 

Those trying to navigate the Pound Sterling this week and next should remember that financial markets have a tendency to buy a rumour and then sell the news. What does that mean? Well, for example, consider last year when we were waiting for Dominic Raab, the then Brexit Secretary to potentially head to Brussels for an emergency meeting ahead of the Brexit deadline. Upon reports that he would go, the Pound rose aggressively. Upon confirmation that he was actually in the Jag, it jumped back down. Now today Boris will meet Macron but is also expected to meet Michel Barnier this week who, remember, is negotiating on the exact same mandate that the Council offered him when he met with his counterparts from Theresa May’s cabinet. He’s not the guy who can scrap the backstop or come up with many smart exit strategies for the UK so don’t expect much. But, this weekend, Boris will attend the G7 meeting in Biarritz, France. The people there will democratically represent about 54% of the EU population. This lot can decide what they want to allow the UK. Any headlines ahead of this event and whatever the rumour mill produces will determine the direction of the Pound and, with confirmation or denial, any gains made could be unwound so there’s a strong argument to be on your toes! 

 

 

 

Discussion and Analysis by Charles Porter

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Morning Brief – Tuesday 20th

In the long run, we’re all dead

 

The quotation above is from legendary British economist John Maynard Keynes. These thoughts were offered in relation to the phenomena of fixed exchange rates but resonate strongly when considering yesterday’s market movements. US Commerce Secretary, Wilbur Ross, announced yesterday that the Trump administration would delay sanctions on the infamous Chinese Technology company Huawei.

 

Markets and consumers alike are alarmingly short-termist. One could easily imagine a dead financial world in which the value of money barely changes between months, years, decades but that’s just part of the human condition: we want everything and, in the words of Veruca Salt, we want it NOW. So when a large threat to trade is kicked yet another 90 days down the road, financial market participants have a tendency to forget it was ever going to happen in the first place. Now, hopefully they won’t all be dead in 90 days (!) but the long-run and its will-it/won’t-it uncertainty will lead to strong liquidations of defensive positions.

 

On the back of the news Gold, the ultimate safehaven in a financial storm, fell back below the key $1,500 per ounce level as the demand for safety fell. Equities rallied in the United States and Europe to the tune of 1% even as some of their respective currencies also gained in value. The US Dollar was the winner of the majors’ game as fears over German inflation and stimulus continued to weaken the Euro. Early in European trading, reports that suggested the German government was hastily preparing fiscal stimulus packages following negative quarterly growth and weak data led the single currency lower. In accordance with this move, the Bundesbank now anticipated a recession in Europe’s largest and most systemically important economy. The Euro lost traction throughout the day but promises of higher long run inflation kept the Euro in reasonable check against the US Dollar.

 

In the United States, the spread between the yield on 2-year dated debt and 10-year duration debt came back from last week’s inversion. Whilst discussing tariffs and trade within the technology sector, Trump also set his sights on the Fed, suggesting a 100-basis point cut was in order. To put that request in context that would mean that the overnight lending rate in the United States would be only 25 basis points more expensive than it presently is in the United Kingdom.

 

The interest rate differential is what drove the Dollar to such lofty heights in 2018. However, as is becoming increasingly more common, traders took absolutely no notice of the request by President Trump, pricing interest rate expectations largely in line with pre-declaration levels. The delay in tariffs and concomitant decrease in risk to global growth prompted investors to unwind long-duration debt holdings in anticipation of higher future growth and pushing an inevitable recession further away. The widening yield spread between the US and Europe, reinforced by improving domestic growth expectations, led the Dollar to a healthy 0.2% intraday gain yesterday. Improving risk sentiment also supported Sterling that had faced a shaky European open following the weekend’s political narrative and leaked Brexit documents. We noted last week that CFTC data showed an extension of the number of contracts held that were betting on the Pound taking a tumble. Whilst last week saw some of these positions liquidated there still remains a significant propensity for short covering to shove the Pound sharply higher. As the government engages in a round of heavy propaganda to shore up sentiment, any lasting improvement in expectations could lead to a hasty closing of these bets and a bid for Sterling. 

 

 

 

Discussion and Analysis by Charles Porter

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