What looked like a savvy move in late April has turned into a nightmare.
Collectively, voters have denied the governing Conservative party a
parliamentary majority. The uncertainty today does not lie yesterday with
the known unknown, but with the shape of
the next government and what it means for Brexit.
The thinking now is that the Tories could form a coalition with the Irish
Unionists, who also favor Brexit. Contrary to expectations, Prime
Minister May has not offered her resignation
and insisted that she will
stay. Our concern pre-election was even in victory May would
be a weaker leader. Some are concerned that another election may have to
be held later this year.
Sterling had appreciated for four consecutive sessions before yesterday
minor decline. It had risen eight of nine sessions. The sharp
sell-off, the bulk of which took place in the immediate reaction to the exit
polls that pointed to a hung parliament as soon as voting ended, took sterling
to about $1.2635 from around $1.2955. In effect, sterling retraced,
almost to the tick, the 38.2% of the rally from the year’s low just below $1.20
in mid-January. The next target is the $1.24-$1.25 area, and that seems to be a reasonable
objective in the coming weeks.
It is understood that UK rates will
be lower for longer. There is a slight bullish steepening move
in the debt market (debt instruments have rallied across the curve with the
short-end rallying more). UK equities are mixed. The FTSE 100, with
its currency sensitivity, has rallied a little more than 0.6%, but the real
performance is mixed, as the FTSE250 is down 0.8%.
We had noted that some investors
had seen the FTSE 100 as a way to
position for the election. If the Tories had expanded their
mandate, UK stocks would have rallied. If the Tories did not do so well,
the rally in FTSE 100 would blunt some of the impacts
from a weaker sterling. Some would have hedged the currency.
The conceit is that a hard or soft Brexit
will be determined by the next government. Once Article 50 was triggered, the initiative shifted
from the UK to the EU. As long as the UK insists on asserting its
sovereignty over its borders it cannot expect to share in the single market,
where sovereignty has been abridged, on
equal footing.
Besides the loss of the Tory majority and the unexpectedly robust showing
for Labour, two other observations stand out in these early hours.
First, the Scottish Nationalist Party did poorly,
and this will undermine efforts for a second referendum. Second,
young people had a very strong turnout–above 70%. It is not clear the
extent that this was a due to Corbyn’s draw or the retaliation for the
referendum where young people typically had voted to remain.
Adding insult to injury, the UK reported softer than expected industrial
production, manufacturing output, and construction. Industrial
production rose 0.2% in April. It was a smaller bounce back from the 0.5%
decline in March than the 0.7% median forecast had it. Manufacturing rose
0.2%, rather than the expected 0.8%. Construction output fell 1.6%.
The median had looked for a 0.4% increase. A saving grace was that the
March series was revised to 0.7% from
-0.7%. The silver lining of today’s data was the trade
balance, where the deficits narrowed, and
revisions narrowed the March shortfall as well.
The reaction to the UK events overshadowed the release of China’s May
inflation figures. Producer price pressures eased for the third
consecutive month, slowing to a 5.5% year-over-year pace, from 6.4% in
April. This is mostly a function of
lower commodity prices and base effect. Consumer prices rose in line with
expectations. The 1.5% pace compares with a 1.2% pace in
April.
The headline figure understates Chinese consumer inflation. The
decline in food prices is ebbing. They have been negative on a
year-over-year basis since February, but the pace is slowing. Excluding
food, consumer prices were up 2.3% year-over-year–in the middle of the
2.0%-2.5% range seen since last 2016. A core measure that excludes food
and energy would show consumer prices up 2.1% up from 1.9% last
December.
The squeeze apparently engineered by Chinese officials that effectively,
intended or otherwise, strengthened the yuan after Moody’s downgrade, appears
to run its course. If offshore investors thought so, the place to
look is the offshore yuan. This week it snapped a four-week
advance. The onshore yuan extended its streak to five.
US rates edged higher this week,
and European rates edged lower. The euro was capped at $1.1285 at the end of last week and the first half of
this week. It recorded the low for the week near $1.1170 in early
European turnover. Look for the $1.1200-$1.1220 area to now offer
resistance. Last week’s low was just above $1.1100. The
turning of interest rate differentials and the loss of upside momentum may make
for a cautious activity. The first round of the French legislative
election will be held Sunday.
Macron’s new party is expected to do very well.
The dollar is finishing the week on a firm note against the yen.
After falling to almost JPY109 in the middle of the week, the dollar clawed its
way back to nearly JPY110.50 today. Rising US yields and the prospect of
a Feb rate hike next week may encourage some re-positioning. The next
target is near JPY110.70, but it may take a move above JPY111.20 to give
confidence that a low is in place.
The US data consists only of April wholesale inventories. An input for GDP calculations, but it is not a
market mover. Canada reports May jobs. It lost 31k
full-time positions in April and gained 3.2k jobs overall. A better
employment report is expected. The
Canadian dollar is off about 0.2% this week. The greenback spiked to
CAD1.3540 earlier today, but the Canadian dollar has recovered. The US
dollar is flirting with the 20-day moving average near CAD1.3510. It has
not closed above that moving average since May 15. A close above
CAD1.3550 would be a very constructive technical development.