Regional issues arise as a deal gets closer
Theresa May and Jean-Claude Juncker were forced to admit defeat in their quest to find an agreement to enable Brexit talks to move to stage two where the future relationship will be discussed.
It seems that the major issue that remains unresolved is the question of the border between the Republic of Ireland and the loyalist North. With the Republic threatening to veto any agreement that creates a hard border and the North refusing any compromise which leaves them being treated any differently to the rest of the U.K., there is going to have to be either a huge compromise or a serious financial inducement.
Either way, the deadline put in place by Donald Tusk has come and gone and talks looks set to continue right up until the Heads of Government meeting next week.
Traders are already very short of Sterling as they have been for some time so the reaction to any positive news sees the pound react far more violently than to bad news.
Yesterday was a case in point with the pound making multi-month highs as a deal appeared close only to drift back to well-worn support levels as hope faded.
Fiscal reform set to be pushed aside
The dollar was driven yesterday by the Fiscal reform bill that is currently being discussed by Senators and congressmen following the vote in its favour in Congress on Friday for the last time as the employment report becomes the focus of traders’ attention. The Senate has its own ideas on tax reform that will be discussed before the administration closes for the holidays.
The employment report is expected to provide confirmation that the FOMC will hike rates at its meeting next week as wage inflation is set to reach 2.5%. While this is still quite low it is moving in the direction most analysts expect. Despite his more pragmatic approach to monetary policy, Fed Chairman elect Jerome Powell has said the conditions needed for him to support a hike are falling into place.
Data will start to become more important to the “new Fed’s” deliberations. Powell is not in favour of pre-emptive action preferring to be guided by facts. This should serve the economy well over the next year or so as growth starts to pick up and inflation remains benign. The dollar index had a quiet day yesterday closing virtually unchanged. The Euro is becalmed which reduces volatility in the index as the common currency makes up more than 50% of the basket.
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Year end to see liquidity fall and volatility rise
It is not unusual for December to be a month where a number of issues that have driven markets over the entire year remain unresolved. Brexit has far reaching consequences for the U.K. in particular, but as stage two of the talks commences, the Euro will also come under scrutiny as the effect of the U.K. leaving the EU will become clear in more practical terms.
The addition of tariffs will make European goods less attractive when compared to other suppliers particularly as the U.K. signs trade agreements with other countries.
The Euro, which has risen close to 20% this year versus the dollar as had little effect on the ability of Eurozone members to exports although the deflationary effect on producer prices has also been welcome.
Even the more successful nations, Germany in particular, has seen inflation actually fall as the currency has gained traction. Now, with sellers lined up as the single currency fails to make progress above 1.20 and the interest rate differential set to widen, it may need to see a substantial pullback before buyers emerge again. It is in neutral territory technically and longer-term investors will want some indication about what equity markets are going to do in 2018 before committing to their currency overlay
