Brexit Talks Move to Stage II, While Greenback Remains Firm

Sufficient progress will be judged to have been made, and negotiations of
the separation between the UK and EU will be allowed to enter the second stage.
The formal decision will be made at next week’s EU summit.  To be sure,
“sufficient progress,” which the diplomatic-speak that does not mean
that any agreement has really been reached, but rather that the UK has made a
few concessionary signals.  

The Irish border issue has not been resolved.  The UK committed
itself to regulatory equivalence, which will mean different thing to different
people.  When the UK leaves, and after a transition period, a hard border
is needed.  The question of where is the customs house and passport
check?  The EU and Ireland say it cannot be between the Republic and
Northern Ireland.  Many Brexiters and the DUP, which itself is a minority
party in North Ireland, reject that it is between Northern Ireland and the rest
of the UK.  Also, the Brexiters are not keen on any role for the European
Court of Justice within the sovereign UK territory.    

The bottom line is that the second stage of negotiations may be just as
trying as the first, and there is less time.
  The EU negotiator
Barnier wants the second stage to be concluded by next October. A final
agreement must be approved by several entities and it will take some

Sterling trading firmly initially after running up smartly yesterday in anticipation
of the agreement. 
It posted an outside up day, trading on both sides
of Wednesday’s range and closing above its high.  Following through buying
was seen briefly, lifting sterling to $1.3520, where sellers emerged ahead of
the week’s high near $1.3540.   There are options struck at $1.3450
(GBP326 mln) and $1.3500 (GBP273 mln) that expire today and could be in

UK interest rates were goosed higher by the news.  The foreign
exchange market largely reacted yesterday to the prospects, but the UK debt
market is responding today.  The two-year yield is up three basis points,
which is the increase on the week, and the 10-year yield is up six basis points
and is up three basis points on the week. 

The economic data were mixed.  Industrial output was flat as
expected after a strong 0.7% gain in September. 
Manufacturing output
rose 0.1%.  However, the slump in construction (-1.7%) was considerable
worse than expected (0.1).  It is the back-to-back decline is the largest
in five years.   On the other hand, the UK reported a smaller trade
deficit than expected and revisions to the September series that reduces the
sting (GBP1.14 bln vs GBP2.75 bln).  

The yen is the weakest of the major currencies today, easing around
  For the week, it is off 1.2%.  The US dollar poked
through the JPY113.50 level for the first time since mid-November.  The
JPY113.25 area corresponded with a key retracement target of the down move
since early November’s peak near JPY11.75.  Today’s dollar gains come
despite the doubling of the initial estimate for Japan’s Q3 GDP from 0.3% to
0.6%, and a larger than expected current account surplus (JPY2.176

The driver for the GDP revision was a boost in business investment from
0.2% to 1.1%. 
When thinking about Japan’s current account surplus,
keep in mind that it is not driven by trade.  Japan’s trade surplus was
JPY430 bln, a fifth of the current account surplus, which is driven by
investment income.  

Separately, China reported a larger than expected November trade surplus
bolstered by a surge in exports.
  The $40.2 bln trade surplus is the
largest in three months and is about $5 bln more than expected.  The
average monthly surplus this year through October had been $33.6 bln. 
Last year’s monthly average was $42.5 bln.  Exports rose 12.3%
year-over-year, up from 6.8% in October, and defying expectations for a
decline.  Imports rose 17.7% year-over-year, up from 17.2% in
October.  Economists had expected imports to have slowed.  China
recently announced some tariff reductions. 

China’s commodity imports surged, with natural gas and copper jumping to
record levels.  Crude oil imports are up 12% through November this year.

Often Australia, and to a lesser extent, New Zealand, are thought to
benefit from China’s commodity imports among the major countries.
New Zealand dollar is the only major currency that is firmer against the US
dollar today, and it slightly at that, while the Australian dollar is a shade

In contrast, Germany reported a smaller than expected October trade
and current account surplus. 
The trade balance fell to 18.9 bln euros
from 24.1 bln.  It is the smallest surplus since April, but there does
seem to be a seasonal component.  Exports fell 0.4% in October, which are
seasonally adjusted, and it is the second consecutive monthly decline after the
2.4% surge in August.  Imports, which were expected to have reversed
September’s 1.0% decline, jumped 1.8%.

France reported a surge in industrial production, led by manufacturing,
and follows yesterday’s German news of an unexpected decline.
strength of the French economy has been a pleasant surprise this year. 
Industrial output jumped 1.9% in October.  Economists had expected a
small decline, and September series was revised to 0.8% from 0.6%.  

The euro is moving lower.  It finished last week just below
$1.19 and tested $1.1730 in the European morning.  It is near a three-week
low. Some pressure is coming from the cross against sterling, which the single
currency was sold briefly through GBP0.8700 for the first time in six months.
  There is a roughly 540 bln euro option struck at $1.1750 expiring
today.  Earlier this week, the euro fell through the uptrend line from
last month, and then mid-week fell below the 38.2% retracement of the November
rally (~$1.1805), and today, was sold through the 50% retracement
(~$1.1760).  The 61.8% retracement is found near $1.1710 and corresponds
to the low from November 21.  

The US reports the November jobs data today.  It often is
among the most important high frequency economic reports.  However,
barring a significant surprise, the market’s focus is elsewhere.  That
said, within the jobs report, the hourly earnings may be the most
important.  It is expected to rise 0.3% and lift the year-over-year rate
to 2.7%.   Investors are very confident the Fed will raise rates next

Late yesterday, Congress extended the spending authorization until
December 22.
  This prevents a government shutdown that could have
taken place beginning tomorrow.  Kicking the can down the road for such a
short period was to get the tax bill passed.  If it is not passed by then,
and we are somewhat skeptical that it will be, the “continuing
resolution” can extend the spending authority further.  The Treasury
Department has said it will begin the now usual measures to operate within the
debt ceiling.  

After a swoon in equity markets in the first half of the week, a recovery
is under way. 
The MSCI Asia Pacific Index rose for its second day
(~0.6%) and recouped about half of this week’s losses coming into today. 
Still, it recorded back-to-back weekly losses for the first time since the end
of June and the start of July.  The Dow Jones Stoxx 600 is up almost 1%
today, which would be the largest gain in almost two months.  It is up
nearly 1.6% this week after have fallen in three of past four weeks.  The
S%P 50 is off 0.2% this week before today’s session.  We suspect it
follow Asia and European markets higher and allow the US benchmark to extend
its advancing streak for a third consecutive week. 


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