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Brexit back as a GBP-negative ahead of UK earnings data.

By Nick Parsons

The GBP began yesterday as the weakest of all the currencies we follow here but ended up as the strongest on what the US financial news channels might call ’Turnaround Tuesday’. On a day of no official economic statistics (though we did get the CBI monthly survey) GBP/USD initially fell to the mid-1.39’s as nervous investors braced for a speech in Vienna from UK Minister for Exiting the EU, David Davis. By the afternoon, a magazine story claiming the EU Parliament favoured a special deal for a post-Brexit Britain helped push ‘cable’ back up over 1.40 with gains between half and three quarters of a cent against the AUD and NZD. Overnight GBP is lower again as domestic political concerns dominate the news agenda.

Tuesday’s rally was based to an ‘exclusive’ report in Business Insider magazine, that the European Parliament is putting together a 60-paragraph document outlining its desire for an "association agreement" with post-Brexit Britain, in a break from the position of the chief EU negotiator Michel Barnier. The European Parliament is pushing for a future relationship with the United Kingdom which could allow for Britain to retain "privileged" access to the single market. This marks a break from the direction previously taken by the EU's negotiating team, which has instead suggested that Theresa May's negotiating red lines mean Britain may only have access to a Canada-style free trade deal. It is claimed the EU Parliament currently plans to put the resolution to its Brexit Steering Group around March 8, before it is adopted at a meeting of all MEPs, also known as a plenary, in mid-March.

The overnight reversal lower in GBP/USD comes after publication of a letter to the Prime Minister from 60 Conservative MP’s forming the European Research Group (ERG) saying that they will no longer support her Brexit plans if members of the cabinet agree tomorrow to keep Britain too closely aligned to the European Union. Although the letter states, “We are writing to reassure you of our continued strong backing for the clear vision of an internationally engaged, free trading global Britain which you laid out at Lancaster House,” the ERG members now reject the “standstill” transition being negotiated by government if the trade deal is not complete by next March, something experts believe is all but impossible. If all this sounds pretty arcane and obscure (it is!), the key point is that the deep divisions in the Conservative Party have once again been very publicly exposed. Only 48 signatures are required to trigger a leadership election and there are 62 on this letter. Let’s see if the unemployment and average earnings figures later this morning can shift the narrative away from Brexit and back on to the economy…

The US Dollar had another pretty good day on Tuesday, its movements largely mirroring those of the main US equity indices. At times when stock markets are rallying, the USD has had an observable tendency to sell-off, whilst any sign of stress in equities has had the opposite effect, leading to something of a safe-haven bid. It would be a huge exaggeration to suggest that yesterday’s stock market moves were on the scale of those seen a couple of weeks ago, but that is what currency traders were largely focused on. The USD index against a basket of major currencies rose half a point from 88.90 to an intra-day best level of 89.40 and it opens this morning at a one-week high of 89.45.

The main attention in US markets was in rates and fixed-income as the US has to sell a record amount of debt this week with three days of auctions of T-bills and notes totaling $258 billion. The 3 and 6-month bill auctions, came at record amounts of $51bn and $45bn respectively but the market had no problems absorbing the massive supply: the 3-month yielded 1.63%, and the 6-month yielded 1.82%. The 2-year auction, meantime, priced at 2.255%; the highest yield since August 2008, one month before the Lehman bankruptcy. Fed funds futures are fully pricing three 25bp rate hikes and put the probability of the Fed raising rates four times this year at 25 percent versus just 17 percent immediately before last week’s US CPI release.

The highlight today will be the release of the Minutes of the January 31st FOMC; just two days before the 666-point drop for the Dow Jones Industrial Average and the subsequent surge in volatility. It was one of the four meetings per year at which no updated economic forecasts or ‘dot points’ are available but the Minutes will be scrutinised for signs the Fed is now leaning more to four, rather than three rate hikes in 2018. The USD index opens this morning around 89.45; more than a full point above its recent 3-year low of 87.95.

The euro made a recently-rare appearance at the bottom of our one-day performance table on Tuesday as investors began to note the German political concerns we first highlighted here yesterday. EUR/USD opened in Sydney in the low 1.24’s but it was a one-way street all the way down to a low around lunchtime in Europe of 1.2325; the lowest since Wednesday last week. The EUR has failed to rally overnight and is now nervously eyeing support from the spike low after US CPI around 1.2285.

In economic news, the ZEW survey of the current economic situation in the eurozone’s largest economy slipped more than expected this month to 92.3, although the latest assessment of Germany’s performance is still the second-highest reading on record. The ZEW indicator is compiled from a survey of banks, insurance companies and in-house finance teams who are asked about their assessments and forecasts for interest rates, stock markets and exchange rates across a clutch of major global economies. It is obviously more prone to influence from short-term market developments and the fall in stock prices during the survey period may well explain much of this month’s decline.

In a very hard-hitting article for Handelsblatt, former ECB Executive Board Member Jurgen Stark writes that, “the ECB’s policy interest rate has lost its steering and signaling functions. Another is that risks are no longer appropriately priced, leading to the misallocation of resources and zombification of banks and companies, which has delayed deleveraging. Yet another is that bond markets are completely distorted, and fiscal consolidation in highly indebted countries has been postponed. So, the benefits of the ECB’s policy are questionable, and its costs indisputable. The current ECB policy is thus simply irresponsible, as is the utter lack of any plan for changing it”. For today, the so-called ‘flash PMI’s’ for services and manufacturing are published for France, Germany and the Eurozone. The EUR opens in London this morning in the low USD1.23’s and GBP/EUR1.13.

Lower stocks, a lower gold price and higher volatility made for a difficult background for the Aussie Dollar even before we factor in the RBA’s very dovish set of Minutes yesterday. AUD/USD struggled to hold on to a US 79 cent ‘big figure’ and has remained below this level ever since 6pm on Tuesday evening. Overnight in Asia it has also broken through Friday’s 0.7895 low, which has also turned the technical picture much more negative.

The Australian Bureau of Statistics reported that its wage price index grew by 0.55% over the December quarter in seasonally adjusted terms, leaving the change on a year earlier at 2.08%. Markets had been expecting a quarterly gain of 0.5%, seeing the year-on-year rate hold steady at 2.0%, so the data was marginally better than consensus. Most of the increase was due to increases in pay for government employees - mainly in the health industry and education - while private sector pay, which accounts for the majority of workers, remained weak at just over 1.9%. Rises through the year in the Public sector ranged from 1.9% for Professional, scientific and technical services to 2.9% for Health care and social assistance and public sector pay has now outpaced that in the private sector for the past four years.

According to Capital Economics and widely quoted in local press, “We suspect that wage growth will creep ever so gradually higher as the unemployment rate edges lower and spare capacity is used up, but it may still just be around 2.2 to 2.3% by the end of this year and perhaps only 2.5% by the end of next year… Wage growth is unlikely to significantly boost household income growth or underlying inflation this year at least, [and] until that changes, the RBA isn’t going to raise interest rates.” For the Australian Dollar, the combination of lower stock markets, higher volatility and higher interest rates offshore looks a pretty negative cocktail and it opens this morning in the mid 78’s against the USD with GBP/AUD at 1.78.

Having spent the whole European morning on a 1.25 ‘big figure’, USD/CAD then spent the whole of the North American day on 1.26 after a disappointing set of wholesale trade numbers and as nerves begin to grow ahead of next Tuesday’s Federal Budget. By the end of the day, it was a close-run thing at the bottom of the one-day table, and only a few pips on the CAD/EUR exchange rate kept the Canadian Dollar off bottom spot.

Statistics Canada reported the value of Canadian wholesale trade dipped 0.5% in December, compared to consensus expectations in a Reuters poll for a monthly increase of 0.4%. Lower sales were recorded in five of the seven subsectors, representing 65 percent of wholesale trade in December, while volumes declined 0.9%. The personal and household goods subsector dropped 3.3% to its lowest level since April 2017 while sales in the miscellaneous subsector fell 2.4% on weakness in the agricultural supplies industry. Taking the calendar year as a whole, wholesale trade in 2017 rose for the eighth year in a row, jumping 9.4%to a new record. The year-over-year increase was the biggest advance since the 13.7% jump in 1997.

For the rest of this week, we have official data on retail sales on Thursday then on Friday its earnings, hours worked and the CPI numbers. The Canadian Dollar opens in Europe this morning with USD/CAD in the mid-1.26’s and GBP/CAD nudging 1.77.

The New Zealand Dollar continued to edge slightly weaker on Tuesday. NZD/USD extended its decline from Friday’s 0.7434 high and at its weakest point during the European afternoon was down almost a full cent from this level. Overnight the weakness of the Aussie Dollar has pressured the AUD/NZD cross lower and it is again testing Friday’s 6-month low of 1.0705, leaving GBP/NZD around 1.90.

The New Zealand Government today published a mammoth report on the economic impact of the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP). The 243-page National Interest Analysis (NIA) estimates the economy would grow between 0.3% and 1% more than if TPP had not existed, with exporters enjoying better access to new markets such as Japan, Canada and Mexico. The NIA estimates tariff savings of $222.4 million in savings annually once fully implemented, with $95.1 million of those savings starting as soon as the deal enters into force. The agreement would also help reduce non-tariff barriers, though the potential benefits are harder to quantify. The report estimates they could range between $363 million to $1.2 billion. Trade Minister David Parker said it supported New Zealanders' jobs and income and protected national sovereignty although National Party said it has yet to formally decide whether to support the newly renegotiated TPP trade deal.

According to the Ministry of Foreign Affairs and Trade's estimates, the less than snappily-named CPTPP is expected to produce between a $1.2b and $4b boost to New Zealand's real GDP. The dairy industry alone is expected to save nearly $86 million in tariffs and the country's exporters would save about $200m in reduced tariffs to just Japan once the reductions are fully implemented. Coming after the latest Global Dairy Trade auction showed the first fall in prices this year, the government report is a reminder of the huge economic importance of that sector. The Kiwi Dollar opens in London in the mid-USD 73’s and just above GBP/NZD1.90.