Yeah, so it turns out that exiting the European Union is probably going to be “bloody” hard for Britain. Who knew?
And it’s made even harder by the fact that Theresa May is promising to be a “bloody difficult woman” throughout the protracted negotiations.
So you know, this is a lot like what’s going on in Washington. As Paul Ryan recently put it, “doing big things is hard.” And it’s made even “hard”er when you’ve got a real “hard”on for a President.
On the heels of some bad press surrounding what was apparently a hellish dinner date between May and Jean-Claude Juncker, Brussels is upping the ante. Literally. “The EU has raised its opening demand for Britain’s Brexit bill to an upfront gross payment of up to €100bn,” FT wrote overnight, based on an analysis of “new stricter demands driven by France and Germany.” The Times went on to say that the new figure follows “direct requests from several member states, [intended to] maximise the liabilities Britain is asked to cover, including post-Brexit farm payments and EU administration fees in 2019 and 2020.”
Furthermore, Brussels has apparently told May she won’t be allowed to join discussions at future EU heads of state meetings.
Basically – and this is just an off-the-cuff assessment – it looks like Brussels is trying to make the upfront bill as large as math will allow. That, in turn, makes it far less likely that this is going to be a streamlined process.
Or, more colloquially, “this is what happens when you’re a bitch”…
Needless to say, the pound got hit on the news.
That sharp slide you see started as soon as this hit:
- UK’S MAY SAID BARRED FROM BREXIT TERM TALKS W/ EU LEADERS:TIMES
A couple of hours later, Brexit Secretary David Davis claimed to have “never seen a number.” And it doesn’t matter according to Davis, because even if he does “see the number,” he “won’t be paying 100 billion.”
“I am quite negative on the pound,” said SEB strategist Richard Falkenhall, before adding, in what is surely an early candidate for understatement of the year, that “there are several parts in the negotiations which to me seem very tricky to find solutions on.”
We also got the first reading on eurozone GDP this morning. The print was inline at 0.5% Q/Q and 1.7% Y/Y.
Elsewhere, oil bounced from 6-week lows after Tuesday’s reported API draws. And thank God for the ostensibly bullish API numbers because just hours before they came down, crude got “bin-Salman’d“:
Now we’ll see if the EIA data confirms. “The API numbers were bullish in terms of what markets were expecting,” Michael Hewson, analyst at CMC Markets told Bloomberg on Wednesday, before cautioning that “[while] people talk about the cuts outweighing the rise in supply from the U.S., I’m not convinced, particularly if China shows signs of slowing down.”
Here’s SocGen’s overnight take:
Overnight moves were dominated by the reaction to a slower pace of iPhone (and iPad) sales in the US, to falling commodity (oil, iron ore and copper) prices, and the front-page headline in the FT – “Brussels hosts gross Brexit ‘bill’ to EUR 100bn. Oil prices have bounced back a bit in Asian trading but even so, softer commodities coming after softer Chinese PMIs have seen Australian equities and the AUD fall overnight in markets thinned-out by holidays in Hong Kong and Tokyo. The US news, which includes a generally soft feel to recent data, has taken 10year Note yields back below 2.30% ahead of the FOMC meeting (announcement at 7pm BST) and renewed concerns about Brexit have put sterling on the back foot, at least for now.
Yesterday was the fifth time Brent prices have traded under USD 50/bbl in the last two months and the fifth time when the promptly bounced, though current spot at $50.24 isn’t exactly encouraging. A clear break would sour sentiment significantly. In FX terms, the vulnerable currencies are NOK and CAD in G10, RUB and COP (much more than MXN of late) in EM. Short NOK/SEK seems a pretty good trade, just in case. As for USD/CAD, a break lower could see the major technical resistance at 1.3840 tested, and I don’t want to go short USD/CAD in blind hope that will hold. A break lower could see us go as far as 1.40, at which time valuation, both against the US dollar but also against AUD and NZD, is pretty irresistible.
In the very long run, currencies still tend to re-convergence with purchasing power parity (PPP), either because relative prices adjust or because the currency moves. The OECD estimates that the USD/CAD PPP exchange rate is around 1.24, quite a bit higher than my simple ‘latte’ index PPP index but also quite a bit below current levels. CAD has tracked oil prices and relative yields in recent years and on oil prices, looks to have over-reacted to the most recent move. When USD/CAD was last above 1.37, Brent was USD 15/bbl cheaper. You can also track the under-performance of the CAD against PPP by looking at it relative to yield spreads. Higher breakeven oil prices for Canadian oil sands than for US shale have seen Canada suffer more than the US from low prices, and stress in the sub-prime mortgage market is hurting sentiment. As long as that translates into widening US/Canadian yield differentials, I’m loathe to dive into CAD longs. But the time to buy is approaching as the valuation gets stretched.
The big events of the day come late. The FOMC announcement is at 7pm BST, and the French Presidential debate between Marine Le pen and Emmanuel Macron starts at 8pm BST 9and goes on for 2 ½ hours). Don’t these people realise there’s a game of football on the telly? The FOMC meeting isn’t expected to result in a policy change, but they will want to keep June ‘live’ and despite softer data, a slightly hawkish bias is likely. Our rates strategists favour a bearish bias once the current event risk is out of the way, because the market only prices three hikes between now and the end of next year. The question is how hawkish the Fed will be. If they are true to form, they will be nudging expectations rather than acting forcefully and that will be more risk-friendly than dollar-friendly. USD/JPY should find further support (though Japanese holidays limit moves for the rest of this week), and higher-yielding currencies are unlikely to suffer. Importantly, absent worse inflation data, the Fed is unlikely to sound hawkish enough to stand in the way of a further move higher in EUR/USD, possibly testing 1.10 before the second round vote on Sunday, and breaking higher next week.