Morning Commentary: Down the Homestretch

Foreign Exchange - Morning Commentary
Down the Homestretch 
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
As with a lot of the European currencies, the British pound has rallied sharply against the USD over the past month although on a year-to-date basis, the pound continues to lag most of its G10 peers. 

Looking forward, the view remains bearish.  In the near term, the overall narrative for G10 currencies is likely to be determined by the global backdrop on a day-to-day basis.  But as we move through the second half of the year, the direction of the GBP should increasingly be driven by the BoE’s monetary policy, the ability of the economy to recover from the global pandemic and Brexit negotiations that have yet to make substantial progress.  

While many countries are dealing with the unprecedented shock from COVID-19, the UK has to also contend with a second shock in the form of Brexit that will lead to a fundamental shift in the UK-EU trading relationship that is unlikely to be smooth.  

This double hit to the economy goes a long way in explaining why UK policy uncertainty remains high.  Granted COVID-19 effects likely drive some of this uncertainty, the comparable US policy uncertainty index has retraced back down around pre-COVID levels, suggesting something other than COVID is driving UK policy uncertainty.  The most logical explanation would be Brexit and the risk premium on 1-year cable options relative to G10 peers supports this.  

Brexit negotiations have failed to make progress despite steps taken to intensify talks. This makes it unlikely that we will see the comprehensive and fastest trade deal in history as promised after the Referendum.  While markets still expect a deal to be struck, it really is the substance of the deal that matters with markets moving beyond the binary thought of no deal is bad and a deal is good.  Ultimately, a skinny deal implies the return of non-tariff barriers.  So while a no deal outcome would have the most immediate negative outcome for the GBP, a skinny deal is likely also bearish.
  • US-China tensions continue to grab headlines.  China announced that it will not accept TikTok’s sale to Microsoft and may take action if a sale is forced in what the Chinese government described as a “planned smash and grab.”  Anti-China sentiment has risen on both sides of the political aisle.  This makes moves against China politically beneficial and suggest we should see a ramp up in rhetoric the closer we get to November.  However, China also knows Trump faces a difficult election, and the US economy remains in a fragile state so it would not be surprising if China took retaliatory measures designed to make a statement. 
  • US Phase 4 talks have made limited progress and will resume today.  No agreement has been made on the extra unemployment aid that expired last month.  The lack of progress has led to the possibility of executive action to restore the eviction moratorium and suspend the payroll tax.  However, suspending the payroll tax appears to be a legal non-starter and would do nothing to help the unemployed who just lost the extra $600/week benefit.  
  • The US Treasury announced that it expected to issue ~$950 billion in debt in Q3, which is roughly $270 billion higher than estimated back in May.  This estimated borrowing number includes additional borrowing in anticipation of future legislation being passed.  With the Republican plan seen as the floor and the Democratic plan seen as the ceiling, the risk is for more than expected debt to be raised.  
  • The Reserve Bank of Australia kept its policy rate and 3-year AGB target unchanged as expected.  The bank also left its 2020 growth forecast unchanged (6% contraction) and revised down its 2021 forecast slightly in light of the shutdown in Victoria.  Overall, the statement skewed slightly dovish relative to the June and July ones. 
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