Week in Focus; week commencing 21 January 2019
Last week was arguably the most crucial week in the Brexit saga since the result of the 2016 referendum with UK PM May’s deal overwhelmingly defeated in Parliament by a record 230 votes. As such, the UK’s departure from the EU hangs in the balance as the nation marches towards the March 29th Article 50 deadline. After the vote, both sides of the argument scrambled to campaign for their preferred route, but, at the time of writing, markets have been provided with little in the way of clarity on what move UK PM May will make next. With a distinct lack of support from her own party, PM May had been expected to find a cross-party solution, however, as it stands, UK opposition leader Jeremy Corbyn is unwilling to engage in talks unless the option of a ‘no-deal’ Brexit is taken off the table; something which May’s peers have suggested would remove her leverage in discussions with the EU. From an EU perspective, this week has seen various officials from the bloc continue to take a hard line with the UK, reiterating that it is not willing to renegotiate with UK PM May unless she shifts her ‘red lines’ of leaving the single market and customs union as highlighted by The EU's chief Brexit negotiator Michel Barnier. As such, market participants await May’s appearance in the House of Commons (21 January) for any clarity on how the PM will attempt to overcome the slew of hurdles in her way. Please see below for a summary of the various options facing PM May:
Extend Article 50 – This is almost an inevitability unless the UK wishes to seriously pursue a no deal Brexit. Even if May’s deal had passed on Tuesday, the logistics of her passing her deal would have required her take this course of action. The EU appear to be willing to engage on the matter, however, the extension is unlikely to stretch beyond July when EU Parliament reconvenes after the May elections. Furthermore, extending Article 50 extends the Brexit process but does little to resolve it.
Opt for a ‘softer’ Brexit – There are various forms this could take, but, would ultimately likely be via a ‘Norway+’ or ‘Common Market 2.0’ agreement which would see the UK retain closer ties to the EU by joining the European Economic Area. At this stage, this could be an option that’d have the backing of a Parliamentary majority given the number of pro-remain rebels in the Conservative Party who could team up with opposition parties. However, this would lead to a huge loss of political capital for May, given the leave contingent in her own party and the belief by some that the alliance would it create with the EU would not fulfil the objectives set by the result of the 2016 referendum. Note; this options would still require an extension to Article 50.
General election – This appears to be the preferred option for the opposition Labour Party, however, the failure of its confidence motion against the government this week makes this outcome less likely unless PM May opts to call one herself in pursuit of her deal.
Second referendum – This remains the backup option for Labour if its bid to trigger a general election fails. This is not Corbyn’s preferred option given the amount of Labour ‘leave’ supporters (as is obviously the case for PM May) but could be his last roll of the dice in order to avoid a no deal Brexit. Note: the logistics of carrying out a second referendum with regards to timing are yet to be confirmed.
No deal – This remains the de facto option for the UK if they are unable to secure a deal with the EU that is passed through UK Parliament. UK Lawmakers are very much against this course of action but unless another solution is obtained then this is the default option.
No Brexit – This could be as a result of a second referendum or the executive withdrawing Article 50 given last year’s ECJ ruling, which stated the UK can unilaterally withdraw Article 50. Such a decision would potentially lead to an implosion of the Conservative Party and potentially even civil unrest in the UK.
With the slew of options on the table ahead of PM May’s appearance in the House of Commons on Monday, traders will be wanting to keep an eye on UK Press over the weekend as that’ll likely provide some insight into what the next step in the Brexit saga is.
UK LABOUR MARKET
Naturally, a bulk of the focus for UK assets will fall on events in Westminster, however, market participants will be mindful of the latest UK jobs report due to be released on Tuesday. Given the current tightness of UK labour market, attention will be particularly centred on earnings metrics with both the headline and ex-bonus average earnings figures forecast to remain at 3.3%. Ahead of the release, RBC notes “the unemployment rate should remain at 4.1% for a third consecutive month keeping it close to record lows and below the BoE’s estimate of the long-run equilibrium rate of unemployment”. However, the Canadian bank ultimately concludes that “none of this really matters at the moment as far as the outlook for the Bank of England is concerned given the uncertainty of the outcome of Brexit”.
The December meeting saw the central bank draw a close to new asset purchases, enhance its forward guidance on reinvestments and maintain its view that risks to growth remain broadly balanced, whilst opting to insert an acknowledgement that the “balance of risks is moving to the downside”. This time around, little in the way of fresh policy tightening announcements are expected, with markets assigning a mere 42.8% chance probability to a 2019 rate hike. The Bank’s current forward guidance on rates states “the key ECB interest rates to remain at their present levels at least through the summer of 2019”. When the guidance was introduced last year, analysts had seen this as an indication that the ECB could act on rates around September 2019. Given the recent shift in expectations, the ECB will likely have to adjust its communications at some stage if they remain on their current course, however, next week’s meeting is likely too soon for such an adjustment. With this in mind, focus could fall on the bank’s narrative on risks surrounding the Eurozone’s growth outlook; note, the meeting will not be accompanied with staff economic projections. Since the prior meeting, concerns have been raised about the fragility of the Eurozone economic outlook given developments such as the ‘Yellow Vest’ movement in Pairs (ECB’s Villeroy said the protests will deliver "significant short-term consequences"), German 2018 GDP indicating a lacklustre Q4 and broader global factors including US-Chinese trade concerns, potential Chinese slowdown and the fallout from Brexit. Such concerns were highlighted in the minutes of the December meeting, with the account revealing that policymakers had been close to changing their assessment to ‘tilted to the downside’. Therefore, market participants will be mindful over whether the balance of views is now in favour of making such an adjustment; something which Capital Economics believes could take place. In terms of recent central bank rhetoric, hawkish policymakers such as Mersch, Lautenschaleger and Nowotny have suggested that recent developments are still in-fitting with judgements made at the December meeting. However, ECB President Draghi noted that recent economic developments have been weaker than forecast but ultimately concluded that the Eurozone is not heading towards a recession and policy remains very accommodative. Ultimately, Capital Economics suggests that despite the current economic outlook, “it is still too early for the ECB to be seriously contemplating fresh policy stimulus”. Instead, the consultancy touts the possibility of further TLTROs for Italian banks given the arguments presented in the December minutes.
Ahead of next week’s BOJ meeting, Barclays raised its outlook for Japanese monetary policy. The bank retains its forecast for the BOJ to unwind negative interest rates policies in July, after the BOJ has been recently outlining the negative risks from its policies; Barclays now also expects the BOJ to drop its call for an increase in the flexibility of yield curve control a move Barclays sees materialising in April. The bank explains that there are three main reasons behind its call: “1) our outlook for the Fed to hike rates at a slower pace than previously expected, 2) tighter (less stable) financial conditions due to the equity/FX market correction since end-2018; and 3) lower long-term yields (a flatter yield curve) driven by risk-off flows.” Barclays makes the case that the BOJ’s window for normalisation has now narrowed, however, the bank “expects it to consider the trade-off of extraordinary easing (balance between positive and negative effects) and take a discretionary, pragmatic and opportunistic approach with a view to normalisation in the future.
In terms of expectations for the meeting, trader’s focus will be on the quarterly outlook report. The folks at Goldman Sachs expect the BOJ to sharply cut its FY 2019 CPI outlook to (0.9% vs 1.4% in the previous report) on the back of lower crude prices, as well as government-driven cuts to mobile phone charges. Goldman also thinks that the BOJ will likely to revise down its CPI outlooks for FY 2018 and FY 2020, but only marginally (it argues between 0.1-0.2ppts); “that said, we expect the bank to repeat its assertion that upward momentum towards the 2% inflation target remains fundamentally intact in order to avoid fanning additional easing expectations,” Goldman writes, adding that meanwhile, in light of real GDP growth falling into negative territory in Q3 2018, it exists the central bank to cut growth projections for FY 2018 (to 0.8% from 1.4%), though it sees 2019-2020 levels kept broadly unchanged.
This week, the Norges Bank are unanimously expected to keep rates unchanged rate at 0.75%. At the previous meeting, the central bank reaffirmed their intention to raise rates in March as the outlook was essentially unchanged since the October decision. Despite the fall in oil prices leading up to the meeting, the Norges Bank reaffirmed their confidence in a robust domestic economy as a result of a strong regional labour network survey. The concerns expressed about falling oil prices are likely to be less of a factor this time around as prices have risen by 10% since the December meeting, and with oil producer growth picking up locally and core inflation around the Norges’ long-term target of 2% (2.1% YY as of January 10th). ING expect the central bank to follow through with a hike in March and an unchanged rate this time around, despite the “recent financial market turbulence” and “increasingly fragile global growth momentum”.
CANADA RETAIL SALES
Retail sales are expected to rise 0.4% MM in November, and the core measure is seen rising 0.2% MM. RBC's analysts are, however, more pessimistic, forecasting a print of -0.7% MM on the back of the recent slide in gasoline station receipts. "The more interest rate sensitive autos sector is also expected to see a decline of 0.9%," the bank writes, "excluding these two components, nominal sales should rise 0.4% (off-setting the October drop), while overall sales volumes should be flat for the second straight month." RBC also notes that the November manufacturing sales report (released the day before) will likely also be impacted by lower auto sales and gasoline prices.