Optimism takes over. Sterling is the big winner among G10 currencies as traders appear convinced that a breakthrough in Brexit talks is happening. EUR/GBP is trading at ranges not seen since May 2017 while the cable appreciated by 1.60% since the start of the week. Yet PM May will be facing tough challenges at today’s House of Commons appearance, after facing a first defeat in 15 January 2019 Withdrawal Agreement vote, where UK MPs rejected the deal by 230 votes, the biggest defeat in modern British government history.
Indeed, 17 days before official divorce day and almost one month after first MPs vote, no material changes of Brexit deal have been acknowledged, despite May’s attempt to get further concessions in Strasburg on Monday relating to the British backstop. But instead, three documents which are supposedly “meaningful legal assurances” on EU side and “legally binding” according to May have been provided – this remains far from MPs instruction to replace the backstop by alternative arrangements, an argument the Labour Party will make use of when dismissing the arrangement. UK government top lawyer Attorney General Geoffrey Cox is expected to provide a thorough analysis of the add-on documents at the House of Commons and assess whether the content is enforceable (or not) – an announcement UK MPs will be counting on to take their final decision.
Accordingly, although the agreement appears at sight, we consider the binding dimension of recent documents as essential to allow a major reversal. For now, it seems that the scenario tends more towards a second vote session on Wednesday, where UK MPs will be (1) deciding whether or not it wants to leave the EU without a deal (most likely rejected) and (2) ask for a delay of a few months by way of an extension of article 50.
Short-term, we expect EUR/GBP to bounce back along 0.85555 while a major breakthrough could well push the pair along major support at 0.84852 (31/03/2017 low).
EUR/USD bounces back as investors digest Draghi’s speech
After a rough week, where the main event was Draghi’s dovish speech, the single currency has been trading on a firmer footing and erased partially losses. Since last Friday, EUR/USD rose more than 0.85%, from 1.1177 to 1.1276, as investors slowly digest the new outlook for interest rates. Indeed, a couple of days after the announcement that the ECB would put on pause its tightening process, market participants realized that the Federal Reserve was also on pause. Therefore, if interest rate differential is already priced in and is not expected to change any time soon, what investors should focus on? Let’s have a look at growth prospect for both countries.
The FOMC has revised its growth outlook substantially to the downside. At its December meeting, the Fed lowered its growth forecast for 2019 from 2.5%y/y to 2.3% – not a major change, I agree. However, yesterday Atlanta Fed issued fresh growth forecast, which are based on domestic retail sales data, for the first quarter. Economic growth is expected to ease to a 0.2% annualized rate. Looking at the Atlanta GDP Now previous estimations using different output, GDP growth for the first quarter is estimated to be somewhere between 0.2% and 0.5%, which is still much lower than what the Fed calculated in December.
Across the Atlantic, The European Central Bank trimmed its growth forecast for 2019 to 1.5% from 1.8% – a 0.3% downside adjustment. Based on both central banks’ estimates. It seems that the euro area would bear the brunt of the slowdown, which should be ultimately be dollar positive. However, we believe that US growth is widely overestimated, mostly because the positive effect of the tax cut implemented by the Trump administration will fade away, while the cost of debt servicing will channel revenue away from investment and thus growth generation. Indeed, higher interest rates means higher interest payments. Against such a backdrop, we anticipate that the single currency will continue to appreciate against the buck – even though it would be a bumpy road – and will reach 1.15 by the summer and 1.24 at the end of the year.
