Friday, October 18, 2019

Markets rally as Brexit overcomes its first hurdle; is a Fed rate cut imminent?

  • Dollar
  • Gold
  • Pound
  • Stocks

Market recap: A Brexit agreement between the UK and EU pushes pound higher
The UK the EU reached an agreement for Brexit on Thursday, but it still has to go through a vote in the British Parliament on Saturday, October 19th. The Northern Ireland Democratic Unionist Party, which formed a coalition with the British government after the last general election, has signalled that it is not willing to support the Brexit deal, lowering the chances of the Brexit deal successfully passing through Parliament. Sterling surged on the news, closing Tuesday at 1.289’s level, but retreated slightly on Friday morning as investors wait for the result on Saturday’s vote in the House of Commons. The greenback fell across major currencies as a result, with the Dollar Index closing Thursday’s trading session 0.40% lower.

US equities gained as corporate earnings reports continued to beat expectations. Morgan Stanley stood out the most with revenue from fixed-income trading growing 21%, outperforming analyst predictions of a 5% drop. The DJIA inched higher by 0.09%, The S&P500 rose 0.28% and the Nasdaq advanced 0.40%.

Meanwhile, safe haven assets rose slightly on Thursday. Gold closed 0.12% higher and the yen strengthened slightly against the greenback by 0.09%. US Treasuries were mostly flat, with two-year yields rising 2bps to 1.60% and 10-year yields inching higher by 1bps to 1.75%.

Asian markets opened higher on Friday, with the Nikkei leading the pack rising 0.34% on market open. The Hang Seng Index and Straits Times index rose 0.23% and 0.08% on Friday morning respectively.

Markets will be focused on earnings reports from American Express and Coca-Cola releasing later today and whether the latest Brexit agreement can successfully pass through the British Parliament on Saturday.

Today’s analysis: The US-China trade dispute takes its toll on the US economy
US retail sales data for September surprised investors on Wednesday, dropping 0.3% from August’s figure - and well short of analysts’ expectations of a month-on-month growth of 0.3%. The probability of a Fed rate cut at the next monetary policy meeting on October 30th surged from 73.8% to 87.1%, as investors expressed disappointment towards the data.

*Source: CME Group

The worse-than-expected figures also reaffirmed investors’ beliefs that the US economy is slowing down, which is likely because of the ongoing US-China trade war.

*Source: ADSS, Bloomberg

The Fed will most likely take into consideration the US-China trade war at its meeting. US President Donald Trump announced that the two countries have entered the first phase of a trade pact this week, but it has yet to be finalised, meaning there’s still a chance it could possibly break down before then (and China has already said that more discussions must be held before an agreement is formalised between the two). If US-China relations break down before the Fed’s meeting, it will likely indicate a rate cut is just around the corner.

*Source: ADSS, Bloomberg

As the Fed has indicated that the central bank will adopt a more data-centric approach to its decision-making process moving forward, we expect it to cut interest rates by 25bps. But the market has already priced in an 87.1% probability of a rate cut and the dollar is expected to remain little changed on the decision as a result, with the Dollar Index ranging between 97.74 and 97.31.

But if global risks reduce (as a result of a possible Brexit deal before the October 31st deadline or a confirmation of the US-China trade pact) then we will possibly see the dollar sharply weaken against major currencies – and the Fed might hold rates instead. The Dollar Index may then fall initially, possibly to 97.30’s level, before recovering due to the Fed’s decision to leave rates unchanged.

*Source: ADSS, Tradingview
The bears are in control of the dollar and will likely try to retest the two-month low of 97.17 after successfully breaking the initial support levels of 97.56. The bulls will try to keep the bears in check, preventing the Dollar Index from sinking below the support level of 97.56’s level but will likely fail if a Brexit deal passes through the House of Commons or on confirmations of a US-China trade pact.