Market moves have been reasonably modest overnight. The exception has been the GBP, which moved sharply higher after Theresa May said she would give parliament the option of extending Article 50. Fed Chair Powell’s testimony didn’t break any new ground.
After a run of strong gains, in anticipation of a US-China trade war extension, equity markets have stabilised overnight. The Chinese CSI300 equity index fell 1.2% yesterday, partially reversing its 6% rise the previous day after Trump announced he was delaying the March 1st deadline date for higher Chinese import tariffs. The S&P500 is flat on the day, as it meets resistance at the 2,800 level. It’s been a good month for equity markets, with the S&P500 around 3.5% higher and the CSI300 15% higher.
The major market mover over the past 24 hours has been the GBP, which has strengthened 1.2% against the USD to a five month high of 1.3250. UK PM Theresa May told parliament that MPs would be able to vote on extending the Brexit leave date of March 29th, in the event her deal with the EU is voted down next month. May said it would be a "short, limited extension", to no later than June 30th, to avoid the UK having to participate in European parliamentary elections. Conservative MP Sir Oliver Letwin, who had worked on the Cooper amendment which would seek to extend the Brexit leave date, said his bill was “no longer needed”. May’s move to appease moderate Conservatives, such as Letwin, will put pressure on Eurosceptics within her party to support her deal, if they fear that Brexit might be postponed.
In other positive Brexit-related news, Labour leader Jeremy Corbyn said yesterday that his party would formally support a second referendum, if its preferred customs union solution is ruled out by Parliament. Labour will put forward its own amendment for Brexit tomorrow, based on a permanent customs union and a close relationship with the single market. If this does not pass, then Corbyn says Labour will put forward or support an amendment for a second referendum. Furthermore, senior Labour politicians confirmed they would campaign to Remain, if it were a choice between staying in the EU versus Theresa May’s deal. Political commentators do not believe there is a parliamentary majority for a second referendum at present, and cynics believe that Corbyn’s move is aimed at stemming discontent within his party rather than a genuine attempt of cancelling Brexit, as he believes it stands little chance of success.
The GBP moved to its highest level against the EUR since the middle of 2017 (EUR/GBP below 0.86) after the news, while NZD/GBP has fallen back below 0.52. We think the GBP can extend these gains in due course, although the path will undoubtedly remain volatile. The UK parliament has revealed a determination to prevent a no-deal outcome, which reduces the tail risk of a disorderly Brexit, and Labour’s recent change in stance around a second referendum means there is a small chance that the UK could yet stay in the EU (albeit such a decision would probably only be taken if the UK was staring down the barrel of a no-deal scenario). Moreover, the defection of centrist Labour and Conservative MPs to the new Independence Party should reduce the future likelihood of a Corbyn-led government with socialist tendencies.
The USD has weakened around 0.2%, largely due to the surge in the GBP. The EUR is up a modest 0.1% to 1.1375, its highest level in three weeks. The NZD is flat on the day, and continues to face resistance at 0.69.
The other major event overnight was Fed Chair Powell’s semi-annual testimony to the Senate, in which he reiterated that the Fed would be “patient” with interest rates. Powell said the US economy remained healthy, although it faced “crosscurrents” from more volatile financial markets, slowing growth in China and Europe, and uncertainty around US-China trade negotiations and Brexit. The implicit message would appear to be that if the US and China can achieve a trade deal, and global growth and markets rebound, then the Fed might again consider rate hikes. On the more dovish side, Powell noted that people were being pulled back into the labour market, which had created more room for the US economy to grow without overheating. Powell reiterated that the inflation pressures were “muted”. US rates were little moved through the Q&A, and the market continues to price little from the Fed this year, and a rate cut by the end of 2020.
Powell also highlighted the Fed’s review of monetary policy that it is undertaking (the conclusions are expected next year). Powell said “We’re trying to think of ways of making that inflation 2 percent target highly credible, so that inflation averages around 2 percent, rather than only averaging 2 percent in good times and then averaging way less than that in bad times.” Some Fed officials have suggested an “average inflation target”, in which the Fed might deliberately target inflation over 2% to compensate for previous years of undershooting, might be one way to achieve this. While Fed rate hikes are still a possibility if the global risks abate, the Fed’s review is a hurdle for any tightening this year, in our view. If the Fed were to move in the direction of an average inflation target, rate hikes would run counter to a policy aim of getting inflation above 2% for a period.
In economic data, US housing starts were much weaker than expected, but the less volatile building permits data were stronger (building permits tend to provide a lead on housing starts). US consumer confidence also rebounded strongly, consistent with the end of the US government shutdown and recovery in US equity markets. The labour market differential (the difference between jobs plentiful and jobs hard to get) reached an 18 year high, indicative of a very tight US labour market. The US 10 year Treasury yield is 2bps lower on the day, to 2.64%. NZ rates were around 1bp lower yesterday, with no market-moving comments emerging from RBNZ Deputy Governor’s speech on the RBNZ’s proposed bank capital requirements.
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