Morning comment: Brexit in focus

Mantas Vanagas
Emily Nicol

A rollercoaster day on Wall Street saw the S&P500 initially open in the black on Wednesday, although weakness in financial and technology stocks contributed to a subsequent decline. The market rallied back to be roughly flat as news broke that UK PM Theresa May had secured Cabinet approval of the Brexit deal struck between EU and UK negotiators. However, after the 585 page Withdrawal Agreement was released, the focus turned back to whether the deal – which as expected included a UK-wide customs backstop – would receive broader parliamentary support (far from assured, with May possibly facing resignations and a leadership challenge even before a vote can be held). The ‘risk off’ tone in equity markets combined with a slightly softer-than-expected core CPI reading placed a small degree of downward pressure on US Treasury yields and on the US dollar. After the US close Fed Chair Jerome Powell spoke at a Dallas Fed conference. Powell covered well-trodden ground, maintaining an upbeat view of the US economic outlook and indicating no great concern about recent market volatility.

With that background markets across Asia have been mixed on Thursday. After slumping in afternoon trade to a 1% loss on Wednesday, China’s CSI300 posted a 1.2% rebound today. Markets in Hong Kong and Taiwan were also firmer. By contrast Japan’s TOPIX fell 0.2%, not helped by a firmer yen. A late recovery saw Australia’s ASX200 rise 0.1% as investors eventually shrugged off a stronger Australian dollar – the latter mostly a response to a firmer-than-expected October Labour Force survey (more on this below). Australian bond yields closed 2-3bps higher.

After a more-than-five-hour meeting yesterday, white smoke emerged in Downing Street when PM Theresa May confirmed that the Cabinet had eventually approved the UK’s Brexit deal with the EU. The Prime Minister hinted that, unsurprisingly, the Irish border backstop had caused the most heated debates. Indeed, the Withdrawal Agreement foresees that the UK will remain in a customs union with the EU and will adopt some measures in the areas of state aid, competition, taxation labour and environmental standards, etc., to ensure a level playing field. Northern Ireland, meanwhile, will also have to follow additional Single Market rules and regulations – something that the DUP and Brexiteers will undoubtedly oppose. With respect to the contentious ‘backstop’, it has been agreed that it will come into effect if a future EU-UK relationship is not applicable by the end of 2020, although the UK can request an extension to the transition period before 1 July 2020. Of course, with a limited time period to negotiate a trade deal – trade talks normally take years – this extension clause would appear to be an attempt to ease some concerns.  While some Brexiters worry that the arrangement might lock the UK in the close relationship with the EU for years, some Europeans also appear to have concerns. EU27 ambassadors will meet this week to discuss the deal, and, “if nothing extraordinary happens”, the European Council will hold a leaders’ summit on 25 November, where the deal is expected to be approved. But the main concern for Theresa May will be getting this deal through parliament later in December. The news that Brexit Secretary Raab has just resigned will go no way to ease these concerns either, while reports suggest that Eurosceptic Tory backbenchers are gathering support to trigger a no confidence vote. So while the reaction in financial markets to the news so far has been mildly positive, the dynamic might reverse almost at any stage and even possible over the coming days. 

The data focus in the UK, meanwhile, will be October’s retail sales. While retail sector surveys have signalled a soft start to the fourth quarter, expectations are for a modest pickup in sales (0.2%M/M) in October albeit not enough to offset the decline seen in September. Supply-wise, the DMO will sell longer-dated (2037) Gilts.

Euro area:
A quieter day for euro area top-tier data today got underway with the release of new car registrations figures for October, which recorded another weak showing at the start of Q4. In particular, new car registrations were down 7.3%Y/Y, following a more-than 24%Y/Y decline in September. But even stripping out some month-to-month volatility, registrations over the past three months were almost 3% lower than the same period a year ago. The same was also true of registrations in Germany and Italy, down 5.6%3M/Y and 11.3%3M/Y respectively. Admittedly, recent weakness has been driven by the introduction of new ‘WLTP’ (Worldwide Harmonised Light Vehicle Test Procedure) emission-testing standards. So, when looking through this distortion, on a year-to-date basis growth was still relatively strong, at 2.9%YTD/Y, about 1ppt below the average pace in the first half of the year, suggesting that household consumption is likely to have provided ongoing modest support to euro area GDP growth at the start of Q4. But while the increase in car registrations on this basis were still strong in France (5.7%YTD/Y) and Spain (9.8%YTD/Y), it slowed again in Germany (1.4%YTD/Y) and was down in Italy (-3.4%YTD/Y).

Euro area trade data for September are also due today and expected to report a drop in export values at the end of Q3. In addition, ECB Executive Board members Cœuré, Praet and de Guindos are due to speak at separate events.

Like in the UK, the US data focus today will be October retail sales, with expectations for a notable pickup at the start of Q4, underpinned by stronger vehicle sales and post-hurricane-related spending. This afternoon will also bring the Empire Manufacturing and Philly Fed indices for November, import price data for October and weekly jobless claims figures.

Following on from yesterday’s mixed activity reports, today China reported home price data for October. According to Bloomberg’s calculations, the simple average price movement across all cities was 1.0%M/M – the same as in September. While the growth recorded over the past two months is less than seen during the months of June through August, annual growth in prices still picked up to 9.7%Y/Y from 8.9%Y/Y previously. Prices in 1st tier cities were stable during the month and up just 1.2%Y/Y. However, price increases remained vigorous in 2nd and 3rd tier cities, where annual inflation now sits at 10.1%Y/Y and 10.2%Y/Y respectively.

The focus in Australia today remained on the labour market with the release of the Labour Force survey for October. Employment grew a stronger-than-expected 32.8k during the month. And with growth also revised modestly higher in September, annual growth in employment picked up 0.2ppt to a very strong 2.5%Y/Y. The detail was even more favourable with full-time employment rising a further 42.3k – now up strongly for five consecutive months – raising annual growth to 2.8%Y/Y. Part-time employment fell 9.5k but was up 1.8%Y/Y. The number of hours worked rose 0.3%M/M, lifting annual growth by 0.2ppt to 2.1%Y/Y. With GDP growth running in a 3¼-3½% range, this implies that growth in labour productivity is running at a little over 1%Y/Y. Importantly, despite a modest rise in the labour force participation rate, the unemployment rate remained at the surprise 6½-year low of 5.0% that had been reached last month, whereas the market had expected at least a small degree of payback. A tightening labour market should maintain gradual upward pressure on wage growth, in line with the RBA’s expectations.   

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