Market can't find balance (Daily analysis 5.12.2018)

05.12.2018 13:15 | Marcin Lipka

From extreme optimism to pessimism. The government crisis in the UK and weak data on PMI from the UK. The zloty weakens due to external factors and the MPC meeting. The euro close to 4.29 boundary.

The most important macro data (CET - Central European Time). Surveys of macro data are based on information from Bloomberg unless noted otherwise.

  • Press conference after Polish MPC meeting.

Moods fluctuate

Yesterday's panic on the US markets may be a little surprising. It is hard to determine what evokes fear among investors. The fact of the reversing part of the yield curve of the Treasury bonds is interesting. However, it is not fundamental whether the difference between bonds maturing in two-year and five-year is 2 basis points in the plus or 5 basis points in the minus. Anyway, as history shows, the difference between these instruments may be close to zero for many quarters before the outbreak of a deeper slowdown or recession. Theoretically, the market should look at the difference between current rates (e.g. three-month T-bills or ultimately annual treasuries) and 10-year instruments. Here, all the time, instruments with a longer maturity have higher yields than those with a shorter maturity.

Perhaps, investors are not interested in a partial reversal of the yield curve, but foreign trade issues. Here, it is also difficult to find a weak point. Lack of details of the agreement is natural before the start of formal negotiations. If the details were known, there would be no need for talks. Anyway, the Chinese side is already suggesting preparations to start importing soya and liquefied gas from the United States, which is an element indicating an improvement in relations between Washington and Beijing.

The hypothesis can also be made that the market is afraid of too restrictive monetary policy. Expectations of a rapid suspension of interest rate increases have recently begun to dominate the market, but yesterday's speech by John Williams (chairman of the New York Fed, the third most important person in FOMC) suggests that if macroeconomic data is good, gradual interest rate increases will continue for another year or so. This is to some extent connected with the reversal of the yield curve (too rapid cooling of the economy). However, this theory is somewhat contradicted by yesterday's drops in yields, although they may have been caused more by escaping to the safe haven and expectations regarding interest rates. So how all this translates into the currency market?

The market is somewhat confused. The dollar is usually supported with a strong sale on the equity markets, but an early termination of interest rate increases due to the economic downturn will hamper it. The Chinese yuan has maintained most of the recent increases, but some emerging market currencies may not be able to cope with too strong external pressure and the flow of capital to the safe haven. In this "mess", the US currency remains relatively stable and is not able to generate stronger movement in either direction.

Pound is up against the wall

The situation in the British Parliament is becoming more and more intriguing. Conservatives are clearly losing power and lost three important votes yesterday. The DUP party in Northern Ireland also turned its back on them. However, it seems that this does not have to be just negative for the pound. The greater influence on the agreement with the EU by parliament may either force the government to a gentle Brexit or increase the chances of not leaving the EU at all. It is also possible for the UK to have an extremely close relationship with the EU, modelled on the Norwegian model (maintenance of the common market, payment of almost full contributions to the EU budget, etc.).

There are few positive indications from British PMI indexes. The aggregate index for manufacturing, construction and services fell to 50.7 points, the lowest since July 2016 (since the vote in favour of Brexit). Excluding the mood just after Brexit, this is the weakest reading in almost 6 years. According to the CIPS and IHS Markit, which prepared the survey, such a low PMI may mean GDP growth of only 0.1% in the Islands in Q4 this year. If the parliamentary crisis is over and Brexit issue has a mild solution, the indexes will probably improve very clearly. For the time being, however, it is too early to forecast a positive solution, which also has an impact on the low valuation of the British currency.

MPC in the limelight

The zloty is depreciating, but these are not particularly strong declines. The EUR/PLN exchange rate fluctuates between 4.28 and 4.29. The currency market reacts to external events, as they are inconsistent for it. For the time being, there are no signs that this external situation will change significantly.

Today, the zloty may be slightly influenced by national events. The dovish's part of the Monetary Policy Council may once again "celebrate" victory. The pressure to increase prices in the following quarters will be reduced: the lowest inflation reading in two years, weak PMI and electricity prices at the same level for households due to the expected subsidies from the state budget. This may be visible at today's conference and cause little harm to the zloty.

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This commentary is not a recommendation within the meaning of Regulation of the Minister of Finance of 19 October 2005. It has been prepared for information purposes only and should not serve as a basis for making any investment decisions. Neither the author nor the publisher can be held liable for investment decisions made on the basis of information contained in this commentary. Copying or duplicating this report without the written permission from Sp. z o.o is prohibited.

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