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Another big week for markets, and I seem to be saying that a lot at present. I guess that happens when there is structural change underway in markets and where participants have so many questions thrown up by the evolving macro dynamics.
Of course, the answers we all seek are not always readily available and often take time to play out. One thing we seem to lack these days is patience.
The new week has started on a fairly limp note, with a mixed picture in Asian equities, with the ASX 200 -0.9%, while the Nikkei 225 and Hang Seng 0.6% and 1.7% respectively. We can see S&P 500 futures +0.5%, helped by moves in Japan but also the early moves higher in crude, which in turn has promoted the CAD as the best performer in G10 FX. The USD index is unchanged, with USDJPY the best performer in G10 and pulling above the 113-handle. GBPUSD is a touch lower and testing the 1.28 level, and we have seen good interest from traders in this pair today.
Trading Brexit 
The lack of any move higher in GBPUSD today is thematic of a market that has fully discounted the weekend EU/UK Withdrawal Agreement. This outcome was never really in doubt for markets anyhow, and the fact it took EU leaders less than an hour to give the terms the tick of approval shows just how they feel about the prospect of this passing their respective parliaments. The real issue, as everyone has noted, is the vote in the UK Commons speculated to be held around the 10 December. As things stand, the numbers just aren’t there with Labour and the DUP Party saying they won’t vote this deal through, while some 25% of May’s own party is not on board. A deal is likely to be voted down.
The market is structurally short GBP, and that will cushion some of the downside should the Meaningful Vote not pass. The fact everyone expects this to be the case suggests GBP rallies should be contained, and we may even see GBP grind lower into the vote. From here anything can happen, but the fact the EU has said this is as good as it gets and May is now selling this as the best and the only deal we shall see makes me feel the scope to negotiate is limited.
Of course, this is the sort of political brinkmanship we should expect from politicians and perhaps faced with the threat of rampant financial market volatility politicians will change their mind. A reworked deal could be an option, but the EU really can’t give the UK too much leeway, as they have elections of their own a couple of months after the Brexit deadline and as things stand, they can sell this current deal to their respective voters as a win under the circumstances.
The fact is, few outside of Britain are really are interested in the developments anyhow. It’s a massive deal for the UK, with over half of exports and imports transacted with the EU in some capacity. So, with the additional tariffs due to be imposed on imports, married with GBP weakness could lead to inflationary pressures, and a poor-quality of inflation as well, that will need to be met with a punchy response from the Bank of England, and this could hurt the housing market in a big way. The EU has less than 10% of its trade transacting with the UK, so while semantics will impact European assets, the fact is when we look a real economics the EU hold all the power here, and a reworked deal is not a given, even if I put the odds at this playing out as just over 50%. In reality, we have to be prepared for a hard Brexit, although the prospect of a leadership challenge or even second referendum would not be out of the question.
I pity those in the UK who have to contend with this as the noise would be deafening, but we are into the business end of the saga and moves in GBP could be huge from here.
As mentioned, the USD is holding up well here, despite interest rate expectations collapsing of late (see the Bloomberg chart below). Here we see US interest rate markets have just 28bp priced in for next calendar year, so around one hike and recall this pricing stood at 61bp a month ago. So, we can say the market bought into this notion that we could see a pause in hikes in 2019. This view will come in front and centre with the line-up of Fed speakers due this week, and the market will trade rates and the USD inline with the tone of the communication.
(Orange line – USD index), white – eurodollar futures Dec18-Dec20) 
(Source: Bloomberg)
EURUSD looking ‘cheap’
Keep in mind that it’s not just that US rate expectations have moved, we have seen a similar dynamic in Europe too. On a relative basis, US rate expectation have come off more aggressively. I chart this using a simple rates model below, and again we can see how well the USD is holding in well, and it could be argued that EURUSD should be closer to 1.16. It goes to show that few want to own EURs when Italian fiscal worries are prevalent, while the data flow is uncompelling. Friday’s European manufacturing PMI data was case-in-point printing 51.5 – the weakest since May 2016 and a fraction from the contraction level. Woe behold those long EURs should Fridays EU CPI (estimate) comes out lower than 2%, even if the pair is ‘cheap’ on a simple rates model. I do sense a turning point in EURUSD though. 
(Orange line – EURUSD, EU/US rate diff)
(source: Bloomberg)
The fact is the appeal to hold each G10 currency is diminishing day-after-day and this benefits gold, which I will look to increase exposure here on a break above $1238. It also benefits Emerging Market currencies too, although that is a punchy call.
G20 meeting in play
There is also much focus on the weekends G20 Summit, although while so many are watching the meeting involving Xi and Trump, and whether there is the platform to avoid further tariffs. We are also now expecting to see OPEC representatives there too, along with Russian involvement.  WTI and Brent crude have re-opened the new week on a positive tone, putting on 0.7% and 1.1% respectively and it’s interesting to see the biggest inflow into US oil fund ETF since June 2017, which is bullish, albeit brave. The net position in Brent futures held by money managers has collapsed of late and again, that could be construed as bullish, as there has a been a decent flush out of positioning and we are back to a historically low level. Of course, that position adjustment is warranted and to see $60 again we will require a defiant stance from OPEC and Russia to commit to balance the market, and that is about as certain as the Brexit playbook.
So, a week then where macro watchers will once again be intently focused on Brexit, USD moves, Fed speakers, Italian bonds, trade tensions and oil markets. So more of the same, but hopefully we start to get more colour and start to hear the answers to the many questions we hold.
Published by Chris Weston, Head of Research, Pepperstone