The UK finally convinced the EU to endorse their Brexit withdrawal agreement. When the announcement was made early this morning, sterling jumped more than 170 pips in a matter of minutes. However it sold off just as quickly as investors turned their focus to the odds of Parliamentary approval. Nearly all of the initial gains were lost by the start of the NY session but as the day progressed, traders dipped their toes back into the currency. We think that the gains in sterling are sustainable because even though Prime Minister Boris Johnson faces an uphill battle to collect all of the votes needed from lawmakers to seal the deal, members of Parliament won’t want to risk another 3 years of policy gridlock or worse – an unruly no deal Brexit. Its true that Johnson hasn’t won one Parliamentary vote, he’s lost his majority and faces stiff resistance from the DUP. However this is the closest we’ve been to an orderly exit in years and probably the best deal they’ll get from the EU.
The new Brexit agreement bears many similarities to Theresa May’s proposal with the biggest different being the Northern Irish border. May’s solution was to keep all of Britain in the European customs union, which Brexiteers vehemently opposed. In Johnson’s deal, there is no hard land border and the entire UK would leave the EU customs union with the exception of Northern Ireland, which would be required to adhere to the same maze of EU customs rules and procedures on trading of goods – this in effect puts a customs and regulatory border down in the Irish Sea.
Now, it all hinges on Super Saturday where Parliament will hold marathon session to determine if they support Johnson’s deal. If they approve the new withdrawal agreement, there are 2 paths. Parliament fast tracks the deal into UK law and they leave the EU on October 31st as scheduled or they get a technical extension to debate the details and set a new date for departure. In the EU’s eyes, a deal is done so they’ll agree to any extension. Either scenario should drive GBP/USD back to 1.30 and beyond. However if Parliament rejects Johnson’s Brexit agreement, there could be a second referendum or a general election and an almost certain collapse in GBP.
Meanwhile another round of weaker US data drove the dollar lower against all of the major currencies. Housing starts and building permits declined in the month of September with starts falling by the largest amount in 7 months. The Philadelphia Fed survey also pulled back, reflecting a slowdown in manufacturing activity that was confirmed by the larger pullback in industrial production. Coming on the heels of yesterday’s softer retail sales report, today’s numbers reinforced expectations for a Fed cut later this month. So far we’ve seen very little pullback in USD/JPY and if the odds of easing is as realistic as the market expects, we think the pair is due for a deeper correction towards 108.
The best performing currency today was the Australian dollar which shot higher on the back of better than expected labor data. While job growth slowed to 14.7K from 37.9K, the unemployment rate dipped to 5.2%. Full time jobs increased 26K as part time jobs fell 11.4K. These numbers tell us that despite the Reserve Bank’s recent rate cut, the labor market is Australia is tight which reduces the chance of further easing form the central bank. We think the RBA is done for the year and with expectations building for another Fed cut, AUD/USD could squeeze up to 70 cents.