Sterling sinks as Brexit deal appears to be in trouble

terling ended a week of extreme volatility sinking against every major currency worldwide. Hopes ran high early in the week as rumors swirled that a draft deal with the EU was imminent. However, once the deal was made public, the furious reaction on the part of the Eurosceptic wing of the Tory party left May’s premiership in doubt and markets reacted sharply. While overshadowed by the Brexit debacle, the US Dollar also had a rough week, as US Treasury rates pulled back sharply after disappointing economic news.

This week the markets are likely to focus on politics, but we’ll also get a few publications from both sides of the Atlantic. The most important releases will include ECB “minutes” out on Thursday and fresh November PMI readings for the Euro Area and the US out on Friday.

It’s worth adding that because of the US Thanksgiving holiday the markets will be thin. Expect exaggerated reactions to political headlines from the UK as Theresa May tries to defend her draft deal as well as her political future.

Major currencies in detail

GBP

Economic news was again completely overshadowed by significant news on Brexit. Optimism about the draft deal reached with the EU dissolved later in the week as several ministers resigned from May’s cabinet in protest over the draft. As this is written, May’s Tory opponents do not yet have enough signatures to force a vote of ‘no confidence’, and Sterling has somewhat stabilized as a result. The immediate focus will be on whether opponents of the deal can gather the 48 signatures required to force the vote. So far the number is about half of that, although some additional MPs are rumored to have signed in secret.

EUR

Brexit news stole the political spotlight last week, but the standoff over the Italian budget continues to provide a headwind for the common currency. Neither Rome nor the European Commission has budged from their respective positions. The standoff initially brought EUR/USD to its lows of the year last week. However, falling US yields damaged Dollar sentiment globally and enabled the common currency to post a modest gain for the week.

The next chapter in the Italian budget saga arrives this Wednesday, as the European Commission decides whether to recommend an opening of an Excessive Deficit Procedure against Rome. However, we should note the process is slow and drawn out and it is unlikely that it will provide many market moving headlines. The Euro could react to the releases for the currency bloc mentioned earlier, but it is likely to trade mostly off the events elsewhere, primarily the UK.

USD

Key inflation data disappointed expectations again in the US. Core consumer inflation, which excludes volatile food and energy components pulled back slightly to 2.1% for the year. In the absence of any new information regarding inflation, we think that the markets now are likely to focus on the statements of the FOMC members, which are likely to continue influencing the Dollar. While we still expect the next hike to happen in December, we think the recent pullback in market expectations for 2019 hikes is justified and we remain skeptical of further Dollar strength from here.