GBP soars on Tory win, JPY sinks on US-China trade agreement; US retail sales

Rates as of 06:30 GMT

Market Recap

Fantastic volatility overnight as UK PM Boorish Johnson wins an overwhelming victory. The Conservatives won in constituencies that they hadn’t held for over 100 year or had never held before. Was that because Johnson was so popular or because Corbyn was so unpopular? Looking at some of the exit polls, I’d say more the latter. The best tweet of the night was from a former Labour Party official: “I guess it turns out that if you ask people to make someone they don’t like prime minister they say no.” But clearly there was also support for Johnson’s single-minded focus on Brexit and his simplistic slogan, “Get Brexit done.”

My view on the pound: I think it can probably rally further on continued short-covering and optimism. But eventually reality will sink in and people will realize that this is only the end of the beginning for Brexit, not the beginning of the end. That’s intensely GBP-negative.

The big lie here is the idea that with his new majority, Johnson can pass the Withdrawal Agreement, leave the EU on 31 January and that’s the end of Brexit. Hah! Here’s a photo, courtesy of my former colleagues at Deutsche Bank, of the recently concluded EU-Canada trade agreement. You can read its 30 chapters and 30 annexes here, or if you want to download all 1,598 pages as one PDF for easier perusing on the train home, try here.

Negotiations for this agreement were first announced in May 2009 and concluded five years later in August 2014. The European Parliament finally agreed to it in February 2017. So eight years from start to (almost) finish – the agreement still had to be ratified by national legislatures after that. And now Britain has a year to negotiate a similar agreement with the EU – plus every other country on earth.

Furthermore, I hate to bring this up but what if Parliament doesn’t actually pass the Withdrawal Agreement? It’s true (I think) that all the Conservative Party candidates standing for election promised to vote for it. But I’m not sure all of them have read it yet, or whether they understand the implications. When they do, they may change their minds, because the deal is apparently worse than what PM May negotiated in one way: it leaves room for trade barriers between Northern Ireland and Great Britian.

I don’t want to get into the details of this, because a) it’s fantastically complicated, b) you’re not interested, and c) I don’t understand it completely anyway. But trade barriers within the UK could be a deal-killer as far as some people are concerned. The Irish Border was always the insoluble problem of Brexit; it turns out the Johnson government finessed it by lying about what they committed themselves to and hiding it from people.

For anyone interested in the details, I recommend this BBC article, which explains the problem: Will Northern Irish ‘exports’ within UK need checks?

On the other hand, according to Bloomberg, there are now more nationalist MPs in Northern Ireland than there are Unionists. Not only is Johnson no longer dependent on Unionist votes for his majority, the Northern Irish bloc in Parliament probably cares more about trade within the Emerald Isle than trade between Northern Ireland and Britain. That may mean the Conservatives will face less trouble from throwing the Unionists under the bus, but more calls for Northern Ireland to leave the UK.

Similarly with Scotland. Indications are that the Scottish National Party (SNP) won 55 of Scotland’s 59 seats. That would be a decisive rejection of the Conservatives, who held 13 seats in Scotland before the election. The SNP campaigned on promises to try to stop Brexit and to demand another referendum on Scottish independence next year (there was one in September 2014 that resulted in a 55-45 “Remain” vote). Johnson has vowed not to allow the referendum however. Will we be talking about “Scexit” in a few months? While leaving the EU, Johnson has to be careful not to disassemble the United Kingdom at the same time. That would also be profoundly negative for GBP.

Finally, there’s the usual questions about the new government’s economic program. They made pledge after pledge during the campaign, most of which involved spending more money. Johnson won the election by promising working class voters in the north of England and Wales that he would deliver Brexit and address regional imbalances. It remains to be seen what he will actually do.

Separately, Trump appears to have folded like an umbrella in the US-China trade battle. He has agreed to a “Phase One” deal supposedly includes a promise by the Chinese to buy more agricultural products and commitment to “do more to stop intellectual property theft” in return for not raising the tariffs on some $160bn of Chinese goods that was supposed to go into effect on Sunday. They also discussed reducing the existing tariffs. “The terms have been agreed but the legal text has not yet been finalized,” according to Bloomberg. The interesting thing will be how much of this is actually put in writing – there appears to be some debate about that point. And of course we all remember that famous saying, “a verbal contract isn’t worth the paper it’s printed on.”

Nonetheless, even the appearance of a resolution to this phase of the trade war means a “risk on” environment that’s likely to be good for stocks, good for AUD and NZD, and bad for JPY, CHF and gold, as we can see in the movements overnight. As for EUR/USD, the question I have is whether a “risk on” environment means no need for dollars as a safe haven, or does it mean go ahead with carry trades – including EUR/USD carry trades?

It’s curious though that although Trump was tweeting about the UK elections, he was notably silent about this supposed breakthrough in one of his signature battles. Does this mean he recognizes it as a paper victory? Or that there really isn’t anything there? Press reports say an announcement is expected today. Wait for it. If it’s true and they really do sign something, we could have a further “risk-off” move that would be good for AUD/JPY and negative for gold.

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Today’s market

Friday the 13th and the EU leaders meet in Brussels to discuss yesterday’s UK election and climate change, among other topics.

As for the indicators, US import prices are expected to be up slightly on a mom basis. The yoy rate of change – or should I say, the yoy rate of decline – is expected to moderate notably. Much or most of that is probably oil prices though – excluding oil, prices are expected to be down a bit mom, leading the yoy rate of decline to fall further (in this case, fall = become more negative). That can probably be attributed to the continuing decline in China’s producer prices, but we’ve had enough for today so I’ll discuss that next month. In any event, the kneejerk reaction to a moderation of deflation should be USD positive.

US retail sales are one of the biggest US indicators. Although retail sales aren’t the whole story when it comes to household consumption, they’re a large part of the variable story and so are closely watched. Everyone is pinning their hopes on the broad shoulders and deep pockets of the US consumer to sustain growth. As Gov. Brainard said recently, “There are good reasons to expect the economy to grow at a pace modestly above potential over the next year or so, supported by strong consumers and a healthy job market…” Today’s figure is expected to confirm that narrative as retail sales are forecast to grow even faster than the trend that’s been encouraging everyone so much. USD positive

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Finally, on Sunday China announces its retail sales, industrial production (IP) and fixed asset investment (FIA). Both retail sales and industrial production are expected to accelerate, while investment is expected to continue to increase at the same pace as last month. This data would be in line with last Friday’s comments from the Political Bureau of the Communist Party of China Central Committee, which said that the basic trend of steady long-term growth for China’s economy remains unchanged. It certainly doesn’t accord with the fears that a debt-burdened Chinese economy is starting to implode, as many analysts think.

During the coming week (I believe) the annual Central Economic Work Conference will begin in Beijing. Leaders will set China’s economic agenda and the overall policy tone for the coming year. According to press reports, they’re expected “to emphasize quality growth over speed… and strike the right balance between maintaining stable growth and containing economic risks.” “Quality growth” is just a euphemism for “slower growth,” and indeed reports say that they “will likely be more flexible when setting next year’s growth target, showing greater tolerance for slower growth in exchange for policy leeway to carry out longer-term reform objectives that are crucial to the country’s high-quality development.”

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‘The key is not to predict the future, but to prepare for it.’ Pericles, 500 BCE

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