Most currencies stable ahead of central bank rate reviews. But the UK pound falls as a no-deal Brexit looks almost certain and the EU rejects Johnson taunts. AU and NZ interest rates move lower

There has been little movement in most markets overnight as the investors await a series of key events this week, including the FOMC meeting tomorrow night. 

The exception has been the GBP, which has fallen sharply on growing fears of a no-deal Brexit and new elections. 

The only major market mover overnight has been the GBP, which has fallen 1.3% against the USD to a fresh two-year low.  As we reported yesterday, the weekend British press was filled with stories on intensive no-deal preparations within Government, with Boris Johnson’s chief advisor saying that the UK would leave the EU by October 31st “by any means necessary.”  There hasn’t been any let-up in the negative news-flow overnight, with Johnson’s spokeswoman saying that the new British Prime Minister saw no point in meeting European leaders face-to-face until they agree to re-open the Withdrawal Agreement and scrap the Irish backstop.  Johnson’s claim that there was “every chance we can get a deal” has an air of unreality to it, given that the EU has steadfastly refused to budge on either the Withdrawal Agreement and Irish backstop. 

With MPs opposed to a no-deal Brexit, that leaves open the possibility of Johnson attempting to prorogue parliament, in order to force through Brexit by the end of October, or new elections, which would probably be seen as a de facto second referendum.  Speculation of a pre-October 31st election is mounting following weekend polls, which showed a ‘Boris bounce’ for the Conservatives, Johnson’s appointment of former Vote Leave campaign chief Dominic Cummings as one of his key advisors, and the roll-out of several new policies that appear designed to appeal to voters in an election campaign (i.e. more police on streets).  In an election scenario, the risks of both a Johnson-led government – with a possible Brexit ‘mandate’ from the electorate and a Jeremy Corbyn-led Labour government – with its socialist tendencies – are unlikely to be positive for the GBP.  The best outcome in such an event might be a divided parliament with neither major party able to fully implement its planned policies and Brexit delayed further. 

The odds of the UK leaving the EU by October the 31st (presumably, with no deal) have risen close to 40% according to Betfair, and the GBP has fallen accordingly.  The GBP, at 1.2220, is now around 3% from its post-referendum lows against the USD.  The 10 year UK gilt yield fell 3bps to 0.65%, outperforming other major bond markets, with the BoE fully-priced for a rate cut by March next year.  The outlook for the BoE is complicated somewhat by Governor Carney’s impending departure in January next year, with bookmakers having installed Johnson’s former economic advisor and co-founder of the Economists for Brexit group, Gerard Lyons, as the favourite to replace him. 

There hasn’t been much spill-over into broader markets from the sharp fall in GBP and the growing concerns about a no-deal scenario.  US equity markets have given back some of their gains from Friday night’s session, with the S&P500 and NASDAQ 0.2% and 0.5% lower respectively.  The US 10 year Treasury yield has drifted 1bp lower to 2.06%.  While Brexit remains a clear risk on the horizon, investors’ near-term focus is on the Fed’s monetary policy meeting tomorrow night (-25bps expected) and key economic data later this week (nonfarm payrolls and the ISM manufacturing survey).  US-China trade talks resume face-to-face in Shanghai today as well, although expectations are low that there will be any major breakthrough. 

Movements in other currencies have been muted, with all the G10 currencies (ex-GBP) less than 0.2% changed against the USD compared to the end of last week.  The EUR is 0.15% stronger at 1.1140, showing impressive resilience so far this week to the fall-out in GBP.  The NZD has drifted 0.15% lower to 0.6625 and it now sits around the middle of the range seen over the past four months.  The weakness in the GBP has seen the NZD/GBP cross appreciate more than 1% to 0.5420, near its recent highs. 

NZ and Australian rates continued to move lower yesterday.  The Australian 3-year bond fell 5bps to 0.8% in the first few hours of trading yesterday, on seemingly little new information, although it recovered half that fall over the remainder of the session, to end 2.5bps lower in yield.  The market has moved to price a 0.5% terminal RBA cash rate by mid-next year.  The falls in Australian rates filtered through to NZ, with swap rates down 2bps across the curve, to fresh record lows, and the 10 year NZ government bond yield breaking below 1.5% for the first time.  The market now prices a greater than 90% chance of an RBNZ OCR cut at the MPS next week, in-line with our expectations, and a terminal cash rate approaching 0.9% next year. 

The monthly core PCE deflator is released tonight.  Consensus is ostensibly looking for a 1.7% year-on-year increase in June, although the advanced Q2 GDP figure points to a more subdued 1.5% - 1.6% reading.