Sterling steadying but risks remain

UK Government adds to confusion

Yesterday’s newspaper report that the UK is considering proposing to Brussels that the UK remains in the customs union well after 2021 has been contradicted by Prime Minister Theresa May who commented that the UK will leave after the transition period ends in 2020. That is hardly surprising given the radical nature of the idea and the fact that it involves yet another about-turn

This is symptomatic of the way the entire process has been handled and presupposes that; 1) Brussels will accept the proposal 2) any conditions Brussels imposes will be acceptable and 3) the Government can stay in power long enough to pass the legislation that approves such a plan.

The pound has slowed its slide this week and appears, technically, to be bottoming out. Recent experience teaches us that can be an illusion, and should further bad news emerge the slide lower can start again.

Traders are, however, becoming wary of taking up fresh positions at the outer reaches of the perceived medium-term range which is why the fall has slowed. Many were badly burned when the pound made several highs above 1.4300 just a month or so ago. Yesterday, the pound made a low of 1.3474, close to the year’s low of 1.3451 seen earlier in the week and closed a little higher at 1.3516

Next week’s inflation report will briefly divert the markets attention away from Brexit and it is a tough call what the headline number will be. It may be too early for the effect of the pounds fall to be as factor, but it is most likely that the positive wage growth seen in this week’s employment report will be confirmed.

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Euro clinging on as Italian Government policies become a little clearer

The euro remains around the 1.1800 level having traded in a range of 1.1838 and 1.1776 yesterday as the market came to terms with the new Italian Government and its radical policies. A draft of the “manifesto” was reported by the press in which it was confirmed that the new Government will indeed ask the ECB to forgive two hundred and fifty billion euros of debt and create a mechanism that enables countries to leave the single currency.

Neither of these requests will be seen favourably in either Brussels and Frankfurt although in a similar manner to Brexit, the possibility of a country wanting to leave was never seriously considered.

The efforts made by the ECB for the single currency to “fly under the radar” while the economy grew to such an acceptable level to enable to normalization of monetary policy has, as was entirely predictable, been upset by a political drama rather than any macroeconomic issue.

The recent fall in the euro has been magnified as it has coincided with a strong dollar rally but in a similar manner to Sterling, traders are wary of pushing too far past the medium-term target as a correction could easily follow should the dollar run out of steam.

Yields continue to head higher supporting greenback

The dollar continues to be supported by higher yields on Government debt as the ten-year reached 3.12 yesterday. Traders are starting to consider a far more hawkish path for interest rates throughout the rest of 2018 and into next year.

While it is starting to drive the dollar higher, the path for short term rates is far less certain given the FOMC and its Chairman’s reliance of solid data driven factors rather than pre-emption as their major influence.

The path of inflation is still uncertain and the latest employment data was hardly conducive, with the rate of wage increases slowing again.

The dollar index is at a significant point and has tried and failed to break strong resistance at 93.50 conclusively several times already. The daily chart is starting to predict a correction and if the rise in long term yields starts to falter, a correction could be seen allowing the Euro and Sterling to also correct.

Next week starts with a holiday across most of Europe but will be characterized by the release of the minutes of the latest FOMC meeting. Although they have been rendered slightly redundant by events since the May 2nd meeting, traders will want to understand members thinking particularly around inflation and growth.