Market Overview: European Open


Overnight Headlines

  • EU Officials: Johnson's sinister move may not hurt Brexit deal
  • Mnuchin: Claims China trade meeting will happen, won't say when; no intention to intervene on dollar for now
  • Navarro: Unlikely anything quick will happen in China trade talks
  • Yen rises as resurgent gloom drives bets to safe harbours

US equities sold off initially on hard 'no-deal' Brexit fears but bargain-hunters stepped in and the market was bid for the rest of the day and closed on its highs. The 100-day and 200-day moving averages are acting as resistance and support this month as the Dow trades in a range between 25,500 and 26,500.  

USD traded modestly higher, regaining more ground lost after the huge sell-off last Friday when President Trump ratcheted up the trade war once more. The dollar index (DXY) needs to clear previous cycle highs and last week's high around 98.30/45 before it can make a move on the spike high this month near 99.00.

US bonds ended mixed, with 2-year yields closing lower, whilst the 5,10 and 30-year yields ended higher after briefly dipping initially. Yield curve inversion will remain the focus.

The gap between the 2-year and 10-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 we've said before, 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.

The big news yesterday in the UK was PM Johnson's decision to prorogue (suspend) Parliament from mid-September in order to bring through a new legislative agenda. This means Parliament will then 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.

This is now a high-risk game of political manoeuvring which is 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. 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.

Currency Majors

GBP reacted sharply to the suspension of Parliament, dropping more than 1% at one point yesterday, though the 1.22 area is acting as support. The squeeze higher looks to have faltered around 1.23 so cable needs to hold the upper 1.21 zone in order to have a chance of resuming its August rally. More sterling 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 should stabilise.

EUR closed lower for a third straight day, albeit not by much so price action over the last few days has softened the underlying positive tone. A strong move through 1.1050 would indicate that the upward pressure has eased but don't rule out a possible squeeze higher with resistance around 1.1165.

JPY is the strongest major this morning but the 'one day up, one day down' price action in USD/JPY offers little fresh clues. Monday's low bounced off the long-term trendline from the March lows so expect sideways trading to continue between 105 and 107.

Key Events

Watch out for UK political headlines - any signals regarding stronger cooperation between Labour and moderate Tories, with the likelihood of getting a no-confidence vote through next week will be key now the battelines have kicked off. 

Italian President Mattarella will today hand former PM Conte a new mandate to go the extra mile and patch together a deal between the centre-left PD and the anti-establishment party 5SM. We've seen a significant decline in the funding rates for the Italian government as the 10-year Italy bond yield hits all-time lows.

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