Morning Report: 12 October 2017

12th October 2017 By: Ranko Berich

GBP Sterling remained largely unchanged against the dollar but fell against the euro yesterday, however it seems to be finding some firmer ground at the start of the European session this morning. The stabilisation of the Catalan crisis and the aggravation of the British Prime Minister’s situation, now against a challenging Jeremy Corbyn, weighed on sterling yesterday. Probabilities of an interest rate hike remain broadly unchanged, near 80% for early November, but consensus is building with regard to the implications for sterling. Inflation in the UK is among the G10’s highest, and a move by the Bank of England may not imply further tightening to come. As a result, we do not to see a significant appreciation of sterling should interest rates be lifted next month. However, the opposite scenario, a non-event by the BoE, could lead to a sharp drop in sterling. This scenario has started to be priced in the option markets with a significant increase in the demand of put options in case sterling falls within the next month.

EUR The euro enjoyed a relief rally yesterday as the Catalonian crisis calmed down and the Spanish central government appears to have regained control of the situation, at least for the moment. Mariano Rajoy, the Spanish Prime Minister, started the process of activating article 155 of the Spanish constitution, which allows the central government to suppress the autonomic government of a region and control it. As a condition to finally put article 155 into action, Rajoy has given the Catalan government 5 days to confirm whether Catalonia did or did not declare independence unilaterally, regardless of it being suspended for several weeks. Rajoy’s move now puts the ball in Catalan president Carles Puigdemont’s court, whose answer will determine the implementation of article 155 or not. Elsewhere on the continent, French inflation contracted slightly more than expected in September (-0.2% vs -0.1% expected).

USD The dollar continues to slide against the euro, and did not manage to strengthen against a weak sterling yesterday. In our opinion, two reasons are explaining the drop in the US dollar. Firstly, the minutes released yesterday of the last Federal Reserve meeting showed less conviction for a third interest rate hike in 2017. Some Fed officials argued that another hike would depend on the evolution of inflation. The second reason is that markets are dumping the idea that last week’s wage growth data was actually positive for the future of inflation. Last week’s average hourly earnings are calculated as salary divided by hours worked, hence a contraction in the denominator—the numbers of hours worked in total—could actually push the ratio up and send a conflicting message. Lael Brainard, the most critical voice of the dove camp in the Fed, speaks today at 15.30 BST, and could potentially be a market mover.

CAD As the USD was broadly lower yesterday, the Canadian dollar was supported by higher crude oil prices, which have consolidated above $55/barrel. Crude oil inventories data will be released today, and Donald Trump is expected to announce his decision on whether to repeal Iran’s nuclear deal, which will directly determine if Iran’s crude oil exports will be banned again. If Trump goes ahead and repeals the nuclear deal, crude oil prices could rally significantly, which should support CAD.

UK news

  • FT: Spanish prime minister demands clarity on Catalan independence Rajoy says Puigdemont’s response will dictate events as Madrid weighs ‘nuclear option’. Spain’s prime minister has opened the way for Madrid to use a constitutional “nuclear option” to suspend Catalonia’s autonomy, demanding that the regional government makes clear whether it considers itself independent. Mariano Rajoy decided to take the first step towards triggering Article 155 of the Spanish constitution, which would give Madrid previously unused powers to take control of Catalonia’s regional government, after an emergency cabinet meeting on Wednesday. Stepping up pressure on the Catalan government, he has given Carles Puigdemont, the Catalan president, five days to clarify the suspended declaration of independence he made on Tuesday. Mr Rajoy said his formal request for clarity was “necessary when activating Article 155” and would dictate the next steps in the crisis to “offer certainty to the citizens”.
  • Reuters: In Brexit poker, clock narrows transition options Nerves are fraying in the Brexit talks, negotiators are trying to work out if the other side is bluffing about walking away, and a ticking clock is fast narrowing British options come March 2019. Philip Hammond, the chancellor, echoed recent EU assertions when he said that a transition period to some new relationship was a “wasting asset”, the value of which would “diminish significantly” for both sides if its form remains unclear to businesses much after the start of the new year. As negotiators in Brussels make little progress before Prime Minister Theresa May meets EU leaders next week, a warning about a breakdown in talks from a minister seen strongly to favour a business-friendly “bespoke” transition out of the EU came a day after the EU summit chair spoke of a similar new year deadline. Donald Tusk said on Tuesday that if London fails to settle divorce terms by December, and so unlock talks on the transition and future trade pact, then the EU would reconsider its objectives. That reflects mounting doubts across Europe that any legal exit deal can be struck.