Market Update: And so it begins, Game of (Brexit) Thrones

We mentioned in our week ahead commentary that UK MPs would be returning from their Summer recess. And yesterdaysaw the next salvo in the Brexit process with a massive ramping up of the battle lines, between the Brexiteers and Remainers.

To summarise, UK PM Johnson made his gambit in a letter sent to MPs in which he confirmed he is planning to prorogue (suspend) Parliament from mid-September in order to bring through a new legislative agenda. We will also get a spending review rather than a budget, so there will be no new forecasts from the Office for Budget Responsibility of the impact on economic growth of the no-deal Brexit that now looks probable. 

This means Parliament will now not return until the Queen’s Speech on October 14th and essentially narrows the time available for a Brexit debate, and by extension, any attempts to prevent a no-deal. Predictably, those campaigning against Brexit and no-deal claim it’s a constitutional outrage while Brexiteers reply that it’s a legitimate use of the governments powers to choose the timing of the Queen’s speech.

It is obvious this high-risk game of political manoeuvring is now gearing up for next week’s official return of MPs, followed by the party conferences. Among the many options that may occur, a no-confidence vote appears increasingly likely and with it, a general election. This may be the only way to block a ‘no deal’. However, even under a no-confidence vote, PM Johnson may decide to dissolve Parliament and then hold an election at the start of November. Of course, this would come after the Brexit deadline thereby forcing a default Brexit. A further suspension of Article 50 could also occur, providing an extension to negotiations.

What is also clear is that PM Johnson has a major advantage over his current opposition as they are highly disjointed and disunited. Together with the very short timeline, this means that the chances of a no-deal Brexit are increasing, with betting markets now giving this outcome just over a 50% chance from 42% earlier in the week. 

Cable has also reacted, dropping more than 1% at one pointyesterday, though the 1.22 level is acting as support. Moresterling weakness is expected into October as a deal is still unlikely ahead of the EU summit and hard Brexit fears go into overdrive. Of course, if this is averted, then sterling wouldstabilise.

We’ve seen more yield curve inversion in the US this week as the gap between the two-year and ten-year Treasury widened to five basis points, the lowest since March 2007. It’s worth remembering some stats here - in the past fifty years, this inversion, in which shorter-term rates are higher than longer-term ones, has occurred an average of 19 months before the next recession and 12 months before the final peak in the S&P stock market index.

With the longer end 30-year yield hitting record lows, the growing inversion of the yield curve tells us that the market believes Fed policy is too tight and the Fed is increasingly ‘behind the curve’. It also reflects investor scepticism that President Trump’s more conciliatory rhetoric at the start of the week would lead to a swift resolution of the trade dispute. 

Interestingly, we note that several investment banks are now raising their targets for USDCNY, with trading ranges up to 7.50. Ultimately, as long as the risk of large-scale capital outflows is small and the depreciation is controlled, then the currency has most definitely come into play as an additional tool for China to use in its tit-for-tat retaliation.