Pound Plunges on Brexit Woes, US-China Trade Back in Focus

The pound collapsed yesterday following Brexit developments which revived fears that the UK may end up leaving the EU in a chaotic and disorderly manner. With regards to the US-China trade saga, a report noted that the US Trade Representative said that the next round of tariffs on Chinese goods was on hold. Although this was denied by his spokesperson later in the day, US equity indices closed in the green.

GBP Tumbles as May’s Plan and Job Face Opposition

The pound tumbled against all the other G10 currencies after tensions in the UK political landscape escalated, leaving investors highly concerned that the country could end up exiting the EU without any accord. The main gainers were CAD, NZD and NOK, in that order.

After failing to enjoy lasting gains in the aftermath of PM May’s announcement that she secured the backing of her cabinet with regards to the draft Brexit deal, the British currency turned south again and actually plummeted around 300 pips throughout the whole day Thursday. The trigger for the collapse was the resignation of Brexit minister Dominic Raab and several other key ministers in protest of May’s strategy, raising questions over Wednesday’s agreement.

On top of that, at least 14 Tory lawmakers publicly said that they have submitted letters of no confidence in PM May. Lawmakers are not obligated to say openly whether they have done so and thus, the number of the submitted letters may be even higher. For the challenge to be triggered, 15% of Conservative MPs are needed to submit no-confidence letters. The Tories have 315 MPs, so 48 letters are enough to unlock the door that will allow all Conservative MPs to decide whether May should keep her position, or not. May would need to secure a simple majority (at least 158 votes) in order to stay in office, and if she does, she cannot be challenged again for 12 months. On the other hand, if she fails to gather a majority, she must step down and will not be allowed to run in the upcoming leadership election.

As if all these are not enough, May was also attacked in Parliament as well. While presenting her plan, MPs from all sides criticized the draft agreed with the EU, with the “Irish backstop” taking once again centre stage. Northern Ireland’s DUP, the party which May relies on to prop up her minority government, threatened to withdraw its support for the government if the deal will result in a different treatment for Northern Ireland than the rest of the UK.

Yesterday, European Council President Donald Tusk called for an extraordinary summit on the 25thof November in order to finalize and sign off the agreement. However, with all this chaos back in the UK, we don’t know whether and how this actually matters now. Even if EU leaders formalize and seal the deal in less than 10 days, any accord would still have to pass through the UK Parliament. For a while now, we’ve been highlighting that this appears to be a hard task, and yesterday’s developments make it even harder in our view.

As for the pound, we expect it to stay anchored to headlines and news surrounding the Brexit drama, with the icing on the cake being the vote in Parliament. Up until then, we see it unlikely for the currency to establish a clear trending direction, although the risks appear to be tilted to the downside at the moment. As we noted yesterday, the final outcome remains uncertain, with scenarios ranging from a smooth divorce process to a disorderly and chaotic exit without any accord. Any headlines suggesting further escalation are likely to keep the pound under selling interest, while anything pointing to easing tensions may allow some pound buying.

GBP/JPY — Technical Outlook

GBP/JPY plunged on the aforementioned Brexit tensions after it hit resistance near 147.90, to eventually find support at 144.40. Then, the rate rebounded, but the recovery remained limited near 145.45. The pair continues to trade above the upside support line drawn from the low of the 15thof August, but the break below 146.00 signalled the completion of a failure swing top in our view, which leaves the door open for some further declines.

We would expect the bears to take charge again soon and aim for another test near the 144.40 territory, slightly above yesterday’s low, also marked by the inside swing peaks of the 29thand 30thof October. A break below that support may set the stage for extensions towards the aforementioned upside support line or the 143.35 area, which is fractionally above the low of the 30thof October and also coincides with the low of the previous day.

Shifting attention to our short-term momentum indicators, we see that the RSI rebounded from near its 30 line, while the MACD, although below both its zero and trigger lines, shows signs that it could start bottoming. These indicators detect slowing downside momentum and make us cautious that a corrective recovery may be in the works before the next negative leg, perhaps for another test near 145.45, or even the 146.00 hurdle.

In order to start examining the case of larger bullish extensions, we would like to see a clear break above 146.30. Such a move is likely to give buyers the green light to drive the action towards the 147.90 zone. Having said that though, the move that could change the longer-term outlook to a brighter one is a break above the 149.50 zone, or even better above the psychological zone of 150.00. The last time we saw the pair closing above 150.00 was on the 30thof April.

Reports on US-China Trade Support Somewhat Market Sentiment

Switching channel to the US-Sino sequel, the Financial Times reported that US Trade Representative Robert Lighthizer said that the next round of tariffs on Chinese goods was on hold, which may have raised more bets that the two sides are willing to work things out and find a common ground. Although the report was denied by Lighthizer’s spokesperson, US equity indices managed to end their session in the green. That said, we remain sceptical as to whether this positive sentiment could roll over into Europe today. Yesterday, most European indices closed in negative territory, weighed by the turbulence in the Brexit landscape, something that could continue today if headlines suggest further escalation.

Back to trade, focus now turns to the G20 summit scheduled for the 30thof November and 1stof December. Investors will be eager to see whether US President Trump and his Chinese counterpart Xi Jinping can eventually reach consensus. That said, according to a report citing a Trump administration official, China’s response earlier this week to US demands for trade reforms is unlikely to trigger a breakthrough at the G20 gathering. The parts China is not willing to negotiate are unacceptable, according to the US official. Thus, although sentiment around the matter may improve further on positive headlines, we would treat any such boost in risk appetite heading into the G20 summit with caution as there is still the chance for everything to collapse again.

With regards to the FX market, we repeat that our favourite proxy for playing the US-China trade theme is AUD/JPY. When things escalate, the safe haven JPY tends to strengthen, while the Aussie, due to Australia’s strong trade ties with China, tends to weaken. The opposite is true when tensions ease. Nevertheless, at this point, we have to note that all the uncertainty surrounding the UK political scene could well weigh on the broader market sentiment and thereby affect this risk proxy as well.

AUD/JPY -Technical Outlook

AUD/JPY traded higher yesterday after it hit support near 82.15. Nonetheless, the recovery was rejected near 82.90 and then, the rate retreated again. Given that the pair continues to trade above the upside support line drawn from the low of the 26thof October, as well as above all three of our moving averages, we would consider the outlook to be cautiously positive.

We see the case for the bulls to regain control soon and aim for another test near 82.90, or 83.05, the high of last Thursday. That said, we prefer to wait for a break above 83.05 before we get confident on the resumption of the prevailing uptrend. Such a break would confirm a forthcoming higher high and is possible to set the stage for our next resistance, at around 83.60.

Looking at our short-term oscillators, we see that the RSI, although above 50, turned down near its equilibrium line again, while the MACD lies above both its zero and trigger lines but shows signs of slowing down. These indicators suggest that some further retreat may be looming before, and if, the bulls decide to shoot again, perhaps for a test near the upside support line or the 82.15 zone.

Now, if the rate dips below 82.15, it could aim for the 81.75 barrier, the break of which could open the path for Tuesday’s low, at around 81.35. That said, we would like to see a clear close below that barrier before we assume the completion of the reversal as this may confirm a double top formation.

As for Today’s Events

During the European morning, we get Eurozone’s final CPIs for October are due to be released, but as usual, they are expected to confirm the preliminary estimates.

In the US, industrial and manufacturing production for October is coming out. Industrial production is forecast to have slowed somewhat, to +0.2% mom from +0.3%, but manufacturing output is expected to have accelerated to +0.3% mom from +0.2%.

From Canada, we get manufacturing sales for September. The forecast is for a 0.1% mom rebound after a 0.4% slide in August.

We also have three speakers on the schedule; ECB President Mario Draghi, ECB Governing Council member Jens Weidmann and Chicago Fed President Charles Evans.

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