European update – GBP/USD pares gains after data

Investors remain risk averse as multiple concerns weigh

Relatively flat sessions across much of Asia and some weakness in Europe on Wednesday is taking its toll on US futures ahead of the open on Wall Street.

There are a number of worries for investors right now, from the pace of rising bond yields and the impact on investor sentiment, to Italy’s populist coalition playing a game of chicken with the European Commission, stalling Brexit negotiations and the ongoing trade conflict between the US and China. This is all taking its toll on investors and while the US may have recently scaled record highs, supported in a major way by tax reforms passed late last year and the economic fallout from them, others are not faring as well and the longer it goes on, the more it’s likely to catch up with Trump as well.

No one getting too excited despite increasingly positive Brexit reports

The UK is very much in the spotlight this morning, following reports that progress has been made on the Irish border. While traders are yet to get too excited about the prospect of significant progress despite the fact that we are now a week away from the EU summit, at which leaders had previously hoped to have a deal in place to sign off on. It’s been a long time since this was seen as a realistic target but time is running out and at the next summit in November, the pressure will be significantly higher to have an agreement in place or no deal Brexit is going to become increasingly likely.

It does seem over the last 24 hours that reports have been becoming more positive, which has been reflected in the currency but we’re yet to hear anything of substance and fatigue may be setting in from all of the vague and at times, unfounded, claims that’s keep filtering out. There does seem to be something more to the more recent comments but traders are being patient, for now.

European open – Brexit reports provide early lift

UK economy flat lines in August

Sterling has been paring gains since the start of the European session and the raft of UK data hasn’t done anything to put a floor under it. GDP data for August was a little disappointing as the economy didn’t grow following a bumper month in July. It would appear the consumer buzz from the unusually good summer and World Cup has worn off, which was to be expected at a time when the consumer is feeling the squeeze following a period of negative wage growth. The July data was revised higher though which offset the disappointment from the August data.

GBPUSD Daily Chart

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Other figures released alongside the GDP data were a little better with manufacturing and industrial production data exceeding expectations on the month, while numbers for July were also revised higher. Unfortunately, accounting for such a small portion of the economy, this failed to get traders too excited and instead we just saw a collective shrug of the shoulders. As has been the case for some time, politics is driving markets right now and the data just doesn’t have the sway it once did.

Pound extends gains on Brexit noise

Oil slightly lower as Hurricane Michael upgraded

Oil markets remain a particular point of interest having recently risen to 2014 levels and threatening to go higher. It has lost some of its spark over the last week as traders lock in some profits but we’re not yet seeing much appetite for lower prices. With Iranian sanctions coming next month and Hurricane Michael – following its upgrade to category four – threatening some near-term output in the US, the bulls may still feel pretty confident.

The IMF’s warnings on global growth on Tuesday may also have weighed a little but broadly speaking, I think few were surprised at the lower revisions given the environment we currently find ourselves in.

Economic Calendar

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European open – Brexit reports provide early liif

Robbins and Barnier make progress on Irish border

A relatively mixed session in Asia overnight has provided little direction for Europe markets ahead of the open on Tuesday, although it would appear investors haven’t been short of news flow to get their teeth into.

Reports overnight that “meaningful progress” has been made between Theresa May’s chief negotiator Olly Robbins and EU Brexit negotiator Michel Barnier – much to the annoyance of UK Brexit negotiator Dominic Raab I imagine – helped the pound hang on to earlier gains as we enter into a real crunch period for exit talks. Naturally, the report lacked any useful detail but that is something we can hopefully hear more about in the coming hours or days, if this is in fact true which isn’t always the case.

GBPUSD Daily Chart

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Sterling traders – who have been very sensitive to any Brexit-related speculation – were surprisingly unmoved by the reports which emerged late in the evening, although this may simply reflect to constant flow of news we’ve been getting and that this represented more of the message we had been seeing spill out throughout the day. Still, it’s rare cause for optimism, although there’s clearly still some way to go.

Pound extends gains on Brexit noise

Tria seeks to calm investors but stands by budget

Italy has emerged as a greater cause for concern for Europe recently, with the populist coalition of the eurosceptic right and left seizing the first opportunity to collide with Brussels only to find that it is in fact investors that represent a greater risk to their budget plans. Yields on Italian debt have spiked recently after the government proposed widening its fiscal deficit in order to stand by its election promises, something that has drawn criticism from both the European Commission and investors due to both the impact on its already huge debt levels and it’s unrealistic assumptions that risk it missing targets.

Italy’s Finance Minister Giovanni Tria has attempted to take a more calm approach in light of rising yields – very different to the hostility shown by his colleagues to both Brussels and the markets – in an attempt to ease some of the pressure on Italian debt but this is failing to calm fears. Tria stood by the need to spend more and generate more growth but urged calmer discussions with Brussels. Taking on Brussels, providing overly optimistic forecasts and attempting to fuel euroscepticism in the country isn’t the best way for the government to keep investors on side, much to the annoyance of the most vocal anti-establishment figures in government.

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Dollar softens as Trump once again attacks Fed hikes

The dollar has been given some reprieve after US President Donald Trump gave his two cents on the central bank – not for the first time – claiming once again that he’s not too pleased with the pace at which they’re tightening. Trump has taken it upon himself to regularly chime in on the decisions of the independent central bank, something a President would typically refrain from doing so as to avoid blurring the lines between the two.

US Dollar Index Daily Chart

Source – Thomson Reuters Eikon

Some see this as a desire on his part to have more control over interest rates – which may be true – but I think it’s much more simple than that, a force working against him is an annoyance and he’s laying the groundwork early to direct the finger of blame at when the economy stumbles and markets slip.

Oil pares gains as IMF lowers growth forecasts

The latest IMF forecasts could be taking some of the spark out of the oil rally in the near term, with lower growth naturally weighing on demand. Oil continues to be well supported though as Iranian sanctions prepare to come into force, taking significant supply out of the market, while Hurricane Michael in the US is expected to provide some additional near-term supply disruptions.

Brent and WTI Crude Daily Charts

Economic Calendar

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Could be Brexit deal in weeks claims DUP

A Brexit deal is “eminently possible” within weeks but there can be no regulatory barriers within the United Kingdom, the head of the Northern Irish party that props up British Prime Minister Theresa May said on Tuesday.

Less than six months before the UK’s exit from the European Union, there is little clarity about how the world’s fifth largest economy and its preeminent international financial centre will trade with the EU after Brexit.

Talks are snagged on how to avoid checks on the border between Northern Ireland and the Republic of Ireland if the sides fail to clinch a post-Brexit free trade deal.

Reuters

OANDA Market Insights podcast (episode 34)

OANDA Senior Market Analyst Craig Erlam and Stephen Innes, Head of Trading Asia review the week’s business and market news with Jazz FM Business Breakfast presenter Jonny Hart.

This week’s big stories: Bond yields spike, US jobless rate hits 49 year low, Italy launches ambitious budget plan, India the latest EM concern, Brexit and more.

 

Could US jobs data trigger another pop in yields?

US jobs report could add to abundance of positive data this week

Equity markets are trading in the red again on Friday, with bond yields continuing to edge higher as investors price in a more aggressive tightening from the Federal Reserve and possibly others.

There’s been an abundance of strong data points out from the US this week which strongly supports the view that the economy is booming at the moment. Combined with comments earlier in the week from Fed Chairman Jerome Powell, all of this points to higher interest rates for the US – much to the fury, I’m sure, of President Donald Trump – and this is quickly being reflected in the bond markets.

Perhaps there is an element of overly aggressive knee jerk reactions occurring here and possibly even some stops being triggered along the way, further exacerbating the problem, but this is taking its toll on stock markets. That may be a reflection of some portfolio rebalancing or a natural response to rapid increases in yields prompting some profit taking, but we are seeing further declines in Europe and Asia already and US futures are also a tad lower.

DAX slips to 2-week low as U.S treasury yields weigh on markets

Higher rates raise more concerns for emerging markets

The sell-off in commodity stocks is playing a big part of the declines, which may simply be a reflection of the risk-off tone or concerns about growth in emerging markets given the growing number of countries that are coming under the spotlight for all the wrong reasons – with India attracting particular attention this week. There has long been concerns about the impact of US rate hikes on the region but until it starts to drag more on the global economy or offer a much greater risk for the US, I don’t expect it to deter the Fed from going about its business.

The US jobs report today may offer another opportunity for traders to get excited about higher interest rates and trigger another wave of selling, with expectations ahead the release being quite high. The ADP number on Wednesday did nothing to temper expectations and if we get an NFP number in line with that, combined with another drop in the unemployment – taking it to an 18 and a half year low – we could see further gains for the dollar and perhaps a little more risk aversion into the weekend.

US Unemployment Rate

Source – Thomson Reuters Eikon

Was Amazon commitment on wages a sign of an end to low earnings growth?

As always though, the most important number in the release will be the earnings number given that a tight labour market without wage growth raises significant questions about hidden slack in the economy. In a week in which Amazon has promised to raise its minimum wage and urged others to follow though, we may not have to wait long for that to follow and I think a wage growth number starting with a three – not happened since before the financial crisis – could get people quite excited.

In the UK, we were given some reasons to be optimistic this morning – albeit mildly – following reports that a member of EU negotiator Michel Barnier’s team claimed a divorce deal is very close. Traders have become very sensitive to reported comments on the progress of negotiations and while this morning’s response was a little smaller than what we’ve seen previously, it was enough to drive the pound significantly above 1.30 against the dollar and hold there, for now.

NFP – what to expect

GBP jumps on EU optimism of a Brexit deal

With time fast running out, the optimist – and, I hope, realist – in me thinks we should start to hear some positive news on a compromise quite soon as a no deal Brexit is in no one’s best interest, even if the UK would be much worse off in that scenario. How that agreement will look and whether we should prepare for other obstacles once such a deal reaches the parliament stage is another thing. For now, the pound is responding very positively to good Brexit news and unless talks take a dramatic turn for the worse, it may be well supported as we near the eleventh hour deal negotiators love to embrace.

GBPUSD Daily Chart

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Economic Calendar

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Money FM with Craig Erlam – Italy, Brexit, USMCA

Why is Italy threatening to sue the EU? And will disagreements over the Irish border sink Brexit?  Michael Switow from Money FM asks Oanda’s Craig Erlam.

Steady growth continues in UK services sector

Britain’s services sector kept up its steady growth in September but uncertainty about the economy remained high six months ahead of Brexit, a business survey showed on Wednesday.

The IHS Markit/CIPS UK Services Purchasing Managers’ Index (PMI) slipped to 53.9 from 54.3 in August, broadly in line with the median forecast of a Reuters poll of economists that had pointed to a reading of 54.0.

The survey suggested Britain’s economy grew at a quarterly rate of just under 0.4 percent during over the July-September period, data company IHS Markit said — its average growth rate since the Brexit referendum of June 2016.

Reuters

GBP/CAD – Vulnerable to further downside (video)

Nick Batsford, CEO of Core London is joined by Craig Erlam, Senior Market Analyst at OANDA to discuss GBPCAD. Craig explains why he believes the pair could be vulnerable to further selling given the Brexit uncertainty, USMCA deal and rising oil prices.

Italy fears remain, May to reassure on Brexit

Investors unconvinced by promises to trim Italian deficit

It’s been a slightly more positive start to trading on Wednesday as investors welcome reports that the Italian government will seek to reduce the deficit over the next few years.

This follows a week in which the populist coalition government has embarked on a collision course with Brussels over its spending plans, as both parties attempt to stand by election pledges on spending and tax cuts while staying within the euros budget rules and not spreading panic among investors. After it was initially reported that the budget deficit would be 2.4% next year, investors bolted for the exits as this both exceeded expectations and was likely to be very problematic.

News that this will be reduced over the following years with the aim of falling to 2% by 2021 has come as a mild relief – enough for the FTSE MIB to pare some losses and Italian yields to drop slightly – but it’s still higher than investors are clearly comfortable with. It has raised serious questions over the assumptions that have coincided with the projections, whether the targets are achievable and how the government would respond if the deficit doesn’t shrink as they expect.

DAX under pressure over Italy budget

Eurosceptic coalition on collision course with Brussels

This leaves the Italian government on a collision course with Brussels, something I have no doubt they will relish given the eurosceptic views they hold and the opportunity it presents to cast them as unelected and unaccountable dictators seeking to prevent them following the will of the voters. The constant claims about how much better off Italy could be outside the euro – with yesterday’s claims on its own currency solving most problems being the latest – are clearly an attempt to sway public opinion and the budget presents an ideal opportunity to continue these efforts.

In the near-term, concerns about Italy are primarily related to spending and the impact on its already bloated debts but in the longer-term, they also reflect the very real risk that the public could become more eurosceptic and talk of referendums could follow. For now, this is likely to be some time away and the fragility of the Italian banking sector and still large holdings of Italian bonds make investors very nervous.

Italy: risk on, risk off?

May takes to the podium as Brexit talks stall

In the UK, all eyes will be on the Tory annual conference where Prime Minister Theresa May is due to speak. With Brexit negotiations at a standstill as both sides are seemingly unable to agree on a solution to the North Irish border and support for May’s Chequers plan hanging by a thread, people are looking for some much needed clarity on how things will proceed, although they may have to instead settle for more generic optimistic rhetoric and hope for no repeat of last year’s quite shambolic performance.

The pound has been extremely sensitive to any Brexit developments, no matter how significant, so we could see plenty of volatility during today’s speech. There have been reports that May is preparing a compromise on the border issue, in an attempt to get talks moving again, but I struggle to see where May will generate support on this from so it may have the same lifespan as the numerous other failed proposals.

Economic Calendar

For a look at all of today’s economic events, check out our economic calendar.

Italian spending plans and euro commitment weigh

USMCA boost short-lived

US stock markets are expected to open around half a percent lower on Tuesday, reversing much of Monday’s gains as investors quickly move on from the positive trade developments in North America.

Investors were clearly buoyed by the USMCA announcement at the start of the week, with the deal removing one of a number of economic risks for the global economy and potentially acting as a roadmap for similar negotiations with others. That positivity hasn’t lasted long though, with futures appearing to take a lead from Europe which has a number of problems of its own, aside from a trade spat with Trump.

Risk sentiment is shifting and headline-driven

Italian concerns weigh again as official suggests solution lies outside the union

European stock markets and the single currency are trading in the red on Tuesday, with Italian fiscal concerns continuing to weigh on the region. Investors have become increasingly concerned about the coalition government’s spending plans, with the deficit under the proposals being larger than many had expected and leaving Italy on a collision course with Brussels, something that shouldn’t really come as a surprise given their historic eurosceptic views and bullish campaign promises.

EURUSD Daily Chart

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Still, investors are not particularly comfortable with the path that the government has embarked on which has been reflected in the spike in Italian yields, more than 5% decline in the FTSE MIB over the last week and a decline in the single currency. Brexit may well be posing the greatest headache for euro leaders at the moment but this has the potential to cause a much greater one further down the road if it’s not managed carefully.

While the leaders of both Five Star Movement and the League have repeatedly stressed their commitment to the eurozone and EU – despite previous views that somewhat differ – this has frequently been accompanied by comments clearly intended to drum up support for the opposite and this morning’s from Claudion Borghi was no different. The League economy head claimed Italy would solve most of its problems if it had its own currency which aided further declines in the euro and Italian stocks.

EUR/USD – Italian budget crisis pulls euro lower

Sterling under pressure ahead of Tory conference

The pound is also coming under renewed pressure this morning, with yesterday’s spike proving short-lived as reports suggested that Theresa May is willing to offer further concessions on the Irish border in order to get talks moving again. This initially pushed the pound around one cent higher against the dollar but these were quickly reversed and it now finds itself back at three week lows, with traders questioning whether this is something that will get the support it needs from her own lawmakers, let alone the EU.

GBPUSD Daily Chart

The Tory annual conference has provided some interesting soundbites at the start of the week but not much more, with significant divisions clearly still existing on the vision for Brexit and how to get there. All eyes will be on Theresa May’s speech on Wednesday to see whether we get more insight on plans to bridge the divide with the EU and ensure we don’t unintentionally head for a no deal Brexit that could have significant economic consequences, not to mention political ones for the Conservative Party.

Economic Calendar

For a look at all of today’s economic events, check out our economic calendar.