Brexit – What next?

The drubbing that the main UK political parties (Conservatives and Labour) received in the European elections highlights the increasing polarisation of UK politics.  Both took a fudged view on how to go about Brexit while the remainers including the Lib Dems and the hard brexiters led by the newly formed Brexit Part, garnered most votes.  The outcome sends a clear signal of public frustration and impatience at the lack of progress in leaving the EU three years after the Brexit referendum.

A new leader of the Conservative party will likely steer towards a harder Brexit, but this may not resolve the impasse, something that has already brought down Prime Minister Theresa May.  In any case it is unlikely that the EU will want to renegotiate the terms of the Brexit deal agreed with May just because there is a new leader.  Divisions within the Conservative party itself continue to remain stark.  In the meantime Labour leader Corbyn is under pressure to make a clearer shift towards remaining in the EU.

Parliament meanwhile, has already voted against allowing a hard Brexit, suggesting that it is going to be extremely difficult to deliver a no deal or hard Brexit without fresh general elections.  However, as the European elections have shown, fresh UK general elections would spell doom for both the Conservatives and Labour unless they moved to harder stances on either side of the spectrum.  The Conservatives may not risk such an outcome.

This leaves a second referendum as an increasingly viable option, one which would put the question of remaining or a hard Brexit back to the public and out of the hands of parliament.  Indeed given the lack of alternatives and inability of parliament to move forward on Brexit, this may turn out to be the most prescient option although this runs risks of its own including fuelling demands for a fresh Scottish referendum.

GBP has continued to slide amid a clear lack of progress among politicians to arrive at a viable Brexit strategy and increasing risks of a hard Brexit.  However, if markets see a growing chance of a fresh referendum, GBPUSD could reverse some of its recent losses as remain hopes are rekindled, possibly breaking back above 1.30 at the least.   It is not by any means clear that remainers would win such a referendum, but at least they would have a chance that did not exist previously and that could be sufficient to give GBP a bounce.

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ECB meeting, Brexit, Fed minutes, China trade, India elections in focus

This week there a number of key events to focus attention on including European Central Bank (ECB) policy meeting, Federal Reserve FOMC March minutes, the commencement of India’s general elections, China data, and further Brexit developments as UK Prime Minister May tries to gain a further short extension to the Brexit deadline, until June 30.

The better than expected US March jobs report, revealing a bigger than expected 196k increase in jobs, with a softer than expected 0.1% monthly increase in hourly earnings, which effectively revealed a firm jobs market, without major wage pressures, helped US markets close off the week on a positive note. The data adds to further evidence that the Fed may not need to hike policy rates further.

The European Central Bank decision is likely to prove uneventful though recent comments by ECB President Draghi have fuelled speculation that the central bank will introduce a tiered deposit system to alleviate the impact of negative rates on banks.   EUR is unlikely to benefit from this.  Separately Fed FOMC minutes will be scrutinised to ascertain how dovish the Fed has become as the markets shift towards pricing in rate cuts, but it is unlikely that the minutes provide further fuel to interest rate doves.

Friday is the deadline to agree on an extension with the EU to prevent a hard Brexit.  Meanwhile PM May is set to restart talks with opposition Labour Party leader Corbyn to thrash out a cross party agreement on Brexit terms ahead of an EU summit on Wednesday that will look at her request for a Brexit extension until June 30.  GBP has lost momentum lately and investors appear to be fatigued with the daily Brexit news gyrations.

Meanwhile, US-China trade talks appear to be edging towards some sort of a deal while Chinese data this week is also likely to be supportive for risk assets.   As China eases financing conditions, evidence of a pick up in the credit impulse will be evident in March aggregate financing, new loans and money supply data this week.   Meanwhile China’s March trade data is likely to look better or at least less negative than over recent months. This suggests that risk assets will likely fare well this week.

India will be in the spotlight as India’s multi stage elections kick off on Thursday.  Prime Minister Modi is in good stead to ahead of elections, boosted by his government’s reaction to recent terrorist attacks on Indian paramilitary in Kashmir.   Concerns that Modi’s ruling BJP would lose a significant amount of seats in the wake of state election losses towards the end of last year have receded.  Nonetheless, election uncertainties may keep the INR on the backfoot this week.

A world of lower yields

This is yet another important week for Brexit deliberations as UK Prime Minister May, under pressure to resign, may bring her Brexit deal agreed with European Union back to Parliament.   Parliament could vote on different Brexit options in a series of indicative votes as early as Wednesday, including possible options of a soft Brexit or second referendum.  MPs will decide today whether to take control of the parliamentary agenda.  GBP meanwhile continues its two steps forward, one step back trajectory, but appears to be finding solid demand on any down step.

Also in focus this week will be a number of Fed speakers who will speak at a time when bond yields are sliding globally.  Markets were roiled by growth worries at the end of last week following a sharp drop in German manufacturing confidence (The Markit/BME PMI fell to 44.7 in March from 47.6 in February), which dampened hopes that weakness in the Eurozone economy would be temporary.   Taken together with dovish comments from G10 central bankers, the net result was an inversion of the yield curve and German bond yields turned negative.  Such signs have in the past been associated with the onset of a recession.

Despite a host of factors including lower US yields, a more dovish Fed stance, markets shifting towards pricing in US rate cuts, and restrained USD, emerging market (EM) assets have not benefitted greatly.  EM assets are torn between these factors on the one hand and global growth concerns on the other.  A host of idiosyncratic factors, whether it is political noise and pension reform in Brazil, or the impending Moodys’ review of South Africa this week, Thai elections etc, etc, are also resulting in more discriminatory investing.

US –China trade talks will also continue to be in focus this week, with the US administration’s Lighthizer and Mnuchin schedule to be in Beijing on March on Thursday and Friday to meet with China’s Lie He, who is planned to travel to Washington in the week after.  Structural issues such as technology transfers, state subsidies and intellectual property and the removal of all tariffs, have been stumbling blocks so far.  Latest reports reveal that China is refusing to back down on US demands that it eases restrictions on digital trades.   The absence of progress on trade talks are yet another reason for markets to trade under a shadow.

 

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