Tag Archives: EURUSD

Brexit Bill Increased

Discussion and Analysis by Grace Gliksten
 

It has been reported that Prime Minister Theresa May won ministerial support to increase the Brexit offer from €20bn to €40bn yesterday. May is hoping that the increase will unlock stalled negotiations, but has been warned by Eurosceptic colleagues that this is conditional upon securing good transition and trade agreements with the EU. The increase is intended to close the gap between the UK’s initial offer of €20bn and the €60bn expected by the EU.
 
Ministers have speculated that the promise from the UK to respect its outstanding EU commitments could mean a bill of €40bn to €50bn. While the UK accepts some obligations, there are several questions surrounding the full details of these. These include the issue of pensions for EU staff, and how the UK’s contribution is calculated. Another contentious issue surrounds the question of building projects that have had funding approved by all EU states, but where work will not start until the Article 50 process has been completed.
 
The increase was approved by a 10-member subcommittee in Downing Street yesterday. One minister said, “there is consensus behind the prime minister’s position – for now.” Foreign Secretary, Boris Johnson, was part of the subcommittee and one of the members who agreed that the increased offer should be dependent upon the EU opening transition talks in December and settling on an encouraging trade agreement next year. Another member who agreed with Johnson said, “it has to be something for something … this can’t be unconditional money.” Eurosceptic ministers have also said, however, that Britain should be prepared to walk out of talks if a bad trade deal is proposed by the EU. This follows the same tone as May who said, “nothing is agreed until everything is agreed”.
May is expected to wait until the last possible moment before making her improved financial offer. She has confirmed that the offer will only be made when she is sure that it will break the stalemate in negotiations ahead of the EU summit next month. 8th December has been signalled by officials as the date the offer will be made, despite Michel Barnier’s, the EU chief negotiator, pressure to deliver the proposal by the end of this week.
 
May is holding off on the offer in order to gain the most leverage in negotiations.. May is waiting for assurances from EU leaders that the proposal would be received favourably and wants the European Council to declare that first round talks have made “sufficient progress”. She wants the increased offer to help open talks on the transition deal and trade agreements.
Negotiations have been complicated by the current political uncertainty in Germany. The breakdown of talks to form a coalition under Chancellor, Angela Merkel, has left Germany in an unprecedented political crisis. With both the coalition and Merkel’s position unclear, May has been encouraged to exploit the current weakness. However, Thomas Matussek, former German ambassador to the UK, said, “I think German instability is bad news for Britain.” Moderating these comments, he added that he believes that the problems in Berlin would make “no operational difference” to the EU’s position on Brexit.
 
The Pound has benefited from positive Brexit news, improving across the board since the decision. Against the Euro, German political instability has exacerbated Sterling’s strength. The Pound rose 0.69 percent against the Euro, moving from 1.1230 to 1.1305, still short of the gains made at the end of October. It also increased 0.59 percent against the US Dollar, from 1.3175 to 1.3264.
 
 

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Day of Reckoning – Catalonia Part 2

Discussion and Analysis by Charles Porter:

 

This afternoon, the culmination of the Catalonian independence vote may arrive. We analyse the implications within currency markets, predominantly the Euro. In doing so, we offer you an insight into the likely performance of the Euro when it is potentially confronted by a declaration for Catalonian secession later this afternoon.

 

Evidently, Spain has long given up the Peseta, therefore, the effect of the Catalonian referendum upon exchange rates will be localised within the Euro. Given that the single currency brings about de facto insurance to a national idiosyncratic risk (c.f. Mundell 1973), it is possible that the Euro will show relative ambivalence to any possible announcement at around 5pm BST today. The price behind the Euro is still derived primarily from the supply and demand for the currency, however, the understanding behind the value of a currency union must be based upon its cross-border nature. In effect, while the Catalonian referendum might credibly be of national significance, on the Eurozone grand stage, any national effect resembles only a regional shock.

 

The effect within Spanish bonds and equities has certainly been felt. Bonds, for example, are paying a higher yield, reflecting the risk and uncertainty that a Catalonian secession from Spain would create. However, overwhelmingly, these national indicators and markets have managed to remain calm and price the risk modestly. Equities of banks exposed to Spain and Catalonia have been more volatile. These banks have even felt it necessary to insure against a Catalonian secession by insuring their ability to physically relocate and, in the meantime, by adapting their legal headquarters.

 

Whilst our analysis of Carles Puigdemont highlighted his infatuation and belief in Catalonian independence, the constraints that the region’s President faces may precipitate a more moderated response during his speech this afternoon. If the actions taken by Puigdemont are moderate, meaning anything short of a declaration of independence, then I expect a comparable calm within international markets.

 

If Puigdemont pursues a democratic (or bureaucratic/diplomatic) and conversational approach then the risk that is priced into the market reflecting the uncertainty surrounding the Spanish and Catalonian economies will be partially priced out – allowing the Euro and affected Stocks and Bonds to appreciate. Open democracy, conversation and mutual agreement lead to more gradual, predictable, and stable processes, rewarding bonds, equities and assets tied to both economies with more value. Therefore, the effect upon Catalonian and Spanish equities and bonds will be stabilising; lowering the yield on bonds and raising the price of equities and assets.

 

However, in the more unlikely, yet plausible, scenario where Carles Puigdemont achieves and submits a signed declaration of independence then further risk will be priced into the market. Capital will leave the areas most affected by political risk, namely Catalonia and Spain, as uncertainty deteriorates the investment environment. However, given that neither Catalonia nor Spain operate using their own, unique, currency, it must be considered whether the common currency, the Euro, will feel the damage.

 

Whilst the spill over from Catalonia to Spain is inevitable given the analysis within the preceding article, the significance of Catalonia to the Euro is less certain. Accounting for a little over 2% of total Eurozone GDP, Catalonia is not critical to the output and performance of the Euro, but it is also not negligible. Moreover, the longer-lasting potential spill over effect upon both Spanish and Catalonian GDP, should Catalonia become independent and outside the EU, could be strongly negative, particularly if a tariff barrier to trade becomes effective.

 

The fiscal significance of the Eurozone and European Union is clearly low; the European Budget contributes for expenditure of around only 1% of Eurozone GDP. However, Spain’s net European Budgetary contribution to the EU budget will be distorted and the vacuum must be filled by international compensation, or left to fall. With the prospects for European integration increasing according to the foreign policy and integration stance of French President, Emanuel Macron, political risk and fiscal reshuffling could be damaging and disparaging.

 

Perhaps the most valuable present feature of the European Union is the world’s largest single market; free of barriers to entry and internal tariffs. The population of Catalonia as a percentage of the total population of the single market is around 1.5%. To some extent at least, the strength of the single market will be minorly diminished. However, the practical impact of a reduction in potential trading individuals will be negligible given the replenished prospect for further EU accession and an undervalued Euro, for example against the pound, spurring the competitiveness of the Eurozone.

 

The Euro has shown moderate sensitivity to the progression of the Spanish constitutional challenge posed by Catalonia. Regarding the future, highly moderate strength will be conferred upon the Euro if the diplomatic, gradualised, path is taken. Similarly, if unilateral independence is declared this afternoon, the Euro will suffer immediately, and into the trading day tomorrow.

 

 

Although moderately shrugged off by the Euro, the end of trading day spike showing Euro weakness is likely to signal a sell off of Euros before the weekend Catalonian referendum on October 1st. This afternoon’s announcement should prove to be more market sensitive, particularly if the status quo is broken and Puigdemont claims Catalonian independence.

Day of Reckoning – Catalonia Part 1

Discussion and Analysis by Charles Porter:

 

This afternoon, the culmination of the Catalonian independence vote may arrive. We analyse the implications within currency markets, predominantly the Euro. In doing so, we offer you an insight into the likely performance of the Euro when it is potentially confronted by a declaration for Catalonian secession later this afternoon.

 

While Carles Puigdemont, Catalan President, prepares to address the Catalonian parliament, the tension inside the Spanish political economy is mounting. Following the now 10-day-old referendum on Sunday 1st October, Puigdemont feels he is vested with a mandate to declare the secession of his municipality from Spain.

 

The uncertainty and conflict that surrounded the initial referendum should impact markets because it signals the propensity for riots and conflict to ensue in response to developments. When Puigdemont addresses parliament, there is an acute risk that the political composition of Spain, including Catalonia, is exposed. What’s more, underlying tensions that are exposed will likely realise their propensity to generate further conflict. Amidst the uncertainty surrounding the extent of devolved powers, particularly policing, pragmatic and responsible public actions cannot be taken for granted.

 

The Spanish Prime Minister, Mariano Rajoy, has vociferously displayed his unwillingness for Catalonia to leave Spain. Members of the incumbent Spanish ruling party have displayed uncompromising stances towards the Catalonian establishment and public displaying empathy or active support for secession. For example, threats to arrest political public office holders seem credible and are generating concern. It is therefore plausible that convoluted instructions will cause irresponsible public law enforcement, thereby escalating the tension between the nation and the region.

 

So Why is Spain such a Big Deal?

 

There are several reasons why Catalonia is pivotal to Spain and, therefore, why Spain is unwilling to allow the nation to secede. These include, but are not limited to, cultural, geographical, economic, and political. Despite a popular desire for secession, the contentious nature of the debate and referendum indicate that many individuals want to remain a part of the Spanish nation and European Union member state. This is likely to be because, ultimately, despite whatever the future holds for both Spain and Catalonia, they have shared an intricate history. The cultural and social ties across the potential border would inevitably be severed.

 

Geographically, Catalonia occupies much of the affluent border with France. With the Pyrenees creating an impasse across much of the border, the corner access point within Catalonia is critical. The potential to lose an area of strategic geographical significance, both in terms of trade and individual utility, is threatening for Spain. The political will for the nation to remain ultimately harks back to a realist defence of safety in numbers and solidarity with neighbours. The potential divorce of Catalonia from Spain would upset the current status quo of fiscal obligations and arrangements, threatening to stagnate politics and remove critical offices.

 

Evidently, economic reasoning is argued to be the most salient factor motivating the exaggerated market responses. Representing around 20% of the GDP of Spain with over 7.5 million inhabitants, the significance of Catalonia, from their fiscal contribution to their purchasing capacity, is a highly valuable national economic attribute. The attractions within Catalonia, not least Barcelona, draw high volumes of tourists each year, bringing a boost to the economy of Spain and the surrounding areas.

 

In part two of this article, we analyse why the Catalonian question is important to the Euro and foreign exchange markets:

Moderate Dollar Strength

Discussion and Analysis by Charles Porter:

Labour market performance within the United States offered a short-lived boost to the US Dollar. However, the rest of the US trading session eroded the underwhelming gains made on the back of convoluted, contradictory employment data. The erosion of the value of the US dollar, for example within the Eurodollar cross, can be partially attributed to Euro re-balancing. However, the perceptibility of a Dollar reversal across all Dollar-related currency pairs suggests an endogenous Dollar retraction.

 

The headline figure of a decrease in the rate of unemployment, by 0.2%, offset weak payrolls data that saw 33,000 jobs lost in September non-farm payrolls data. The effect upon the US Dollar was temporarily positive in response to the unemployment rate. The effect was subdued, however, given the anticipated inaccuracy of hard data to economic performance following a smattering of natural disasters within US territory.

 

The performance of the US dollar against its most globally significant counterpart, the Euro, is particularly intriguing. Displayed below, the currency cross can be shown to continue its intraday trend with almost complete disregard to the US employment data. Having previously analysed the payroll and unemployment figures against the US Dollar, this article instead seeks to examine the erosion of value that has purported to make hard data redundant.

 

 

Last week’s trend of Dollar strength, is presented as a cyclical re-balancing following an unjustifiable spout of Dollar weakness amidst Euro strength. Kick started and maintained by the promise of a before-year-end interest rate hike, the re-balancing of the Euro is derived from expectations of Federal Reserve action, despite a weak rate of inflation. Moreover, whilst geopolitical risk surrounding the Dollar remains high, it is also becoming slightly dated. As investors believe they have fully priced in the enduring risk derived from the heightened tension within the Korean Peninsula, the Dollar is less constrained and can move freely.

 

Political risk and uncertainty within major reserve currencies outside of the US Dollar appear to be mounting. This changes the cost-benefit decision of holding US Dollars – one of a finite and scarce list of international reserve currencies. For example, the Euro is currently being plagued by the Catalonian conundrum. As Puigdemont faces off against Spanish Prime Minister, Mariano Rajoy, the political risk within Spain and potentially the Eurozone, forces investors to factor uncertainty within their allocation decisions, attracting their capital to other currencies. Similarly, with the fifth round of Brexit negotiations scheduled to start this week, the perseverance risk posed by Brexit is reluctant to abate.

 

Perhaps the retrenchment of US Dollar gains following a positive data release is due to market concerns about a forever-stagnant inflation rate. This would imply that following the immediate currency market euphoria that appreciated the US Dollar on the back of strong unemployment data, investors internalised stagnant inflation, in conjunction with accommodative monetary policy and low inflation, to signal the evolution of a new economic paradigm; one where interest may never rise.

 

This perhaps forebodes the later speech of permanent member of the Federal Open Market Committee, the body responsible for setting US interest rates, William Dudley. In his New York address, the President and CEO of the New York Federal Reserve Bank, highlighted that hyper low inflation is likely to be, in part, attributable to “more fundamental structural changes”. Therefore, perhaps the unexplained reversal of gains within the US dollar are down to investors’ repricing the probability of multiple 2018 interest rate hikes.

 

The Dollar has consolidated strong gains this week, trading at more comfortable levels against the Euro and the Pound, and escaping the highs in excess of 1.20 EURUSD and 1.35 GBPUSD. The sustainability of these progressions is likely to be challenged on short term, idiosyncratic bases. Therefore, the medium and long-term trend for the US Dollar appears likely to be biased in favour of a steady and considerable appreciation.

 

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German Elections and Brexit

Our Foreign Exchange Specialist, Charles Porter, speaks with London School of Economics Associate Professor, Dr. Waltraud Schelkle. Regarding Brexit, we discuss how the passing of the German election may accelerate progress within negotiations as well as the possibility, acceptability and likelihood of a Second EU referendum within the UK. 

 

 

 

 

 

 

 

 

 

Understanding the Brexit process, including the rate of progress and the final outcome, is critical when attempting not to get caught out by foreign exchange markets. Our analysis and opinion allows you to make informed decisions and exploit currency market fluctuations to find the best, unique, solution for you.

 

 

Fed Interest Rate Debate

Interview between Charles Porter from SGM Foreign Exchange and Dr. Waltraud Schelkle, professor at the London School of Economics: The Fed Interest Rate Debate.

 

 

In this video we discuss whether the European Sovereign Crisis, the Financial Crisis, and the Great Recession are over.

 

 

Dr. Schelkle argues that an interest rate hike is overdue.

 

 

 

 

Find the Transcript of our interview here:

BoE Carney Speaks to IMF

Discussion and Analysis by Charles Porter:

 

 

Last week, the minutes published following the Monetary Policy Committee’s Decision rallied the pound sterling. This event triggered an appreciation of the Pound Sterling contributing to intraweek gains in excess of 3 percent. Moreover, the Hawkish conclusion delivered by Gertjan Vlieghe, a traditionally Dovish Committee member, signalled a sooner-than-expected rate hike that in turn cemented and developed these gains. However, Carney’s speech today was unable to re-value Sterling.

 

The analysis of Gertjan Vlieghe’s speech reveals that markets reacted strongly to the following inclusion:

 

 

“If these data trends of reducing slack, rising pay pressure, strengthening household spending and robust global growth continue, the appropriate time for a rise in Bank Rate might be as early as in the coming months.”

 

 

The above quotation conforms almost perfectly to the minutes of the Monetary Policy Committee’s minutes-guidance. Sterling appreciated on the back of this speech because it demonstrated Committee-wide concurrence even amongst the more hike-averse members. Therefore, should Carney place more emphasis to an imminent hike or deliver a more Hawkish conclusion, then a further appreciation should be expected to prevail. However, presumably, so long as Carney did not deliver an outstandingly Dovish message, Sterling should maintain its gains and price out any risk of intra-Committee disagreement.

 

Mark Carney, Governor of the Bank of England, delivered a speech to the International Monetary Fund this afternoon at 16:00 BST. Although offering an abridged version to the Fund and their guests, the full publication was available at 4pm and thus currency market movements after this time should reflect, at least in part, Carney’s speech.

 

Validating the above expectations, Carney did side with the Monetary Policy Committee, suggesting that:

 

 

“As the Committee stated last week […] some withdrawal of monetary stimulus is likely to be appropriate over the coming months in order to return inflation sustainably to target.”

 

 

However, the Pound Sterling did not appreciate at all against other currencies, including the Euro and the Dollar. This may perhaps be because Carney did condition against this conclusion:

 

 

“Any prospective increases in Bank Rate would be expected to be at a gradual pace and to a limited extent[…]”

 

 

Therefore, if markets had, arguably unreasonably, predicted a stronger monetary policy tightening, Carney’s words may have cased investors to sell off the currency. This is because the gains that they anticipated, which derive directly from a higher interest rate, may not be realised. Ultimately, the next monetary policy Decision at the beginning of November will prove, or disprove, the Committee’s intentions to raise interest rates.

Germany’s General Election

Discussion and Analysis by Charles Porter:

Germany will head to the polls on Sunday (24th September). The salience of this election to the Eurozone political economy cannot be understated. This article will guide readers through the consequences of a significant European election given the continent’s underlying social, political and economic currents.

 

There are numerous and healthy literatures regarding national elections within political, economic and monetary unions. Perhaps the most interesting of which, and the one utilised within this article, is the informal governance aspect of the European Union (EU). This avenue highlights the importance of non-formal rules alongside Members’ obligations and control within the Union.

 

Given that the Brexit negotiation process has had a less than auspicious dawn, the future Chancellor of Germany alongside the new Bundestag composition, will play a critical role in shaping the departure of the United Kingdom from the EU. Given that insignificant formal progress has been made, future heads of states, not incumbents, will determine the secession agreement. As the winner and composition of government becomes apparent, it will be immensely important to understand how the head of state and supporting government will conduct their affairs within the European Council.

 

A lot is at stake, therefore, for nations other than Germany at their domestic election. The risk, ultimately, will be measured in least-worst terms. Given that the German electoral backdrop and Brexit decision is persistently framed as a negotiation, even a zero-sum game, there is no prospective leader that will offer a free ride, full of concessions, to the UK when leaving the EU. However, some may not push the UK as a far as others in terms of post-secession contributions and trade prospects.

 

However, there is one more certain bonus coming the UK’s way following Germany’s general election. The good news for the UK should arrive despite the result and development of the Chancellorship. This phenomenon is availed by the informal governance literature. Two findings suggest that the national pay-out from the EU budget during the year of a national election is 10 percent higher than normal in favour of the economy experiencing an election. More importantly, the period surrounding a salient national election is also marked by regulatory and conversational stagnation.

 

These findings in conjunction with each other suggest that once the German election is out of the way, there should be less confusion within the European polity and EU institutions. This could facilitate progress with the Brexit process. Notably, the French presidential election also fell within the post-Article 50-declaration period. Therefore, perhaps the deadlock within negotiations will subside and mutually prosperous coalition building and concession granting will prevail.

 

Comments have abounded that the foreign exchange channel has almost exclusively tracked and responded to the political volatility induced by the Brexit process. This is an interesting conclusion given the enabling characteristic of currencies. Nevertheless, given the apparent exposure of foreign exchange markets to Brexit-related turmoil, good attention should be paid to the forthcoming German election at a time where the British Prime Minister sets forth her vision for the UK.

 

 

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The Week Ahead

Discussion and Analysis by Charles Porter:

 

The week that is now behind us has been eventful and tumultuous. One overarching characteristic was a bullish Pound Sterling. Driven by statistics releases and central bank activity, the Pound finished the week trading at its strongest rate against the US Dollar since 23rd June 2016. The intra-week gains for the Pound stand at around 3%. Looking ahead, we await to see whether Mark Carney shares the hiking-sentiment of the rest of the Committee, the Federal Reserve Bank’s Rate Decision and the result of the German general election.

 

Tuesday began the Pound’s rally, when Sterling jumped by around 0.5% within most currency pairs. The leap was caused by above-expectation and strongly above-target inflation statistics, as measured by the Consumer Price Index, released by the ONS. Despite representing a weakness of the currency in terms of the purchasing power of goods, the currency gained strength as markets priced in a higher probability of an interest rate hike.

 

Sterling was raised higher against both the Dollar and the Euro following the publication of minutes from the Bank of England’s Monetary Policy Committee on Thursday. Whilst these minutes confirmed a relative consensus against a rate-hike, they did also signal the willingness of the Committee to raise interest rates in the near future should current trends persist. This message was then confirmed by Committee member, Gertjan Vlieghe, in a hawkish conclusion that rallied the Pound.

 

Similar upside risk will manifest itself on Monday afternoon of next week when the Bank’s Governor, Mark Carney, speaks at the International Monetary Fund. Should Carney confirm, or even accelerate, the Committee’s intention to raise interest rates in the near future, then Sterling should gain an even firmer stronghold. However, the corollary is also true, should Carney establish a more Dovish tone, the expectation-induced currency gains may be eliminated and even reversed.

 

Perhaps more importantly, Wednesday will see the Federal Reserve Board decide upon interest rate targets within the United States. Whilst a tightening of monetary policy through the avenue of interest rates seems highly unlikely, a plan for curtailing the asset purchase program, quantitative easing, could well be forecasted. Therefore, considerable upside risk may similarly exist within the Dollar, providing the potential to arrest its year-to-date slide within major currency pairs. Clarifications of the Board’s monetary policy positioning should be availed through numerous conferences and speeches by Members.

 

Not wanting to be left out, Mario Draghi will also speak in Frankfurt. The ECB President’s last two speeches at the Nobel Laureate Meeting, Lindau, and then Federal Reserve Bank, Jackson Hole, have secured strong and lasting gains for the Euro. We will therefore await to see whether the content and normative message within Draghi’s speech can solidify this trend and send the Euro back to its monthly highs.

 

Perhaps most importantly of all, Germany will hold its general election on Sunday. The resulting Chancellor, decided within the second vote on the ballot, will be critical in determining the path of European integration and Eurozone completion. The political economy of Europe, given Macron’s presidency in France, could paint an optimistic picture for virtuous integration. Therefore, towards the end of the week, all eyes will be turned towards the German election.

 

 

Skyscraper view

The State of the European Union

Discussion and Analysis by Charles Porter:

 

This morning, before the European Parliament, Jean-Claude Juncker, president of the European Commission, gave the annual State of the European Union address. Juncker’s speech gave a daring and interesting presentation of the present and future state of the Union. A number of interesting events and currency movements arose from this speech. Specifically, two polarised references to Turkey are analysed within this article.

 

Juncker’s dichotomous comments regarding Turkey centred upon, firstly, the nation’s support surrounding the European migration crisis. The second concerns Turkey’s accession prospects.

 

The European migrant crisis has been curtailed thanks to the agreement with Turkey, Juncker explains. The consequences of this deal include a control over the loss of life within the Central Mediterranean route and a curtailment of the pressures upon boarder forces within the EU’s periphery. This could seemingly be confused for support of Turkey’s European role and progression of accession prospects. However, Juncker’s second mention of the nation was far more damning.

 

Turkey first applied to join the-then European Economic Community in 1987. Following the millennium, however, it has seen what is best described as stagnant, if not receding, progress. This empirical truth remains despite the commencement of formal negotiations in 2005. Today, the State of the Union address cemented this fate. Referencing the centrality of European values within the accession negotiation procedure, Juncker stated firmly that EU membership is comprehensively ruled out “for the foreseeable future”.

 

The currency market reaction to this proclamation from the Commission president will provide an indication of what degree of strength, if any, the Turkish economy derives from its prospective membership and integration within the European project.

 

Interestingly, not only was the Lira highly stable in the immediate aftermath of President Junker’s remarks but the intraday differential within the Euro-Lira exchange rate was negligible. Whilst there was considerable volatility within the currency pair, this was in no small part due to the tumultuous episodes the Euro itself experienced today. Because derogatory remarks about the socio-political complexion of Turkey’s incumbent government did not destabilise the Lira it may suggest that the possibility of accession, despite formal application, was never considered credible by currency markets and thus never priced into the Lira’s currency pairs.

 

Alternatively, yet perhaps less likely, it may suggest that the net economic benefits of membership are negligible. This event is important because it could, in theory, have represented the manifestation of an idiosyncratic, niche, reshuffling of a currency’s valuation. Given Juncker’s positive comments today regarding the credibility of Balkan state accessions, the two divergent hypotheses above might be analytically testable in the future.