Brexit and ECB: sorry to see you EU leave

The ECB meeting later today is the key highlight in the economic calendar this week. It is the final meeting for ECB President Mario Draghi, who leaves the position later this month, ushering in his successor, former IMF chief Christine Lagarde. There is virtually no expectation of any policy change from Draghi and co. today, after September’s raft of new measures, including policy support and the reignition of the ECB’s QE programme.

How will the markets react to Draghi’s swansong? 

In the lead up to this meeting, stock markets across Europe are higher. Developed world stock markets are higher across the board, with some close, or touching record highs. However, most stock indices are stuck in fairly tight ranges, and although they are close to record highs there seems to be a lack of conviction in stock markets at the moment, possibly because stocks are being driven higher by a mixture of central bank stimulus and hopes for a breakthrough between the US/ China trade war. European stocks have been led higher by the loosening of monetary policy last month, the question now is will the same dovish policy be maintained under Christine Lagarde? 

Could the ECB become less dovish over time? 

Mario Draghi’s final meeting as ECB President comes at a divided time for the central bank. One third of ECB members voted against last month’s rate cut and QE package, which is the most divided the ECB has been since Draghi’s tenure began in 2011. Will Christine Lagarde try to win a greater consensus over policy? If so, then we could see the ECB become less dovish in the coming months. The FX market doesn’t seem to take the prospect of a less dovish policy shift at the ECB seriously right now, and as we lead up to this meeting EUR/USD is down some 30 pips. However, EUR/USD still remains close to the 1.1170 high from last week, which was the highest level since August. If Draghi makes any concessions to the hawkish element of the ECB, even if he only uses words, then we could see a wave of euro strength grip the FX market as we move towards the end of this week. 

What next for Brexit 

Elsewhere, Brexit remains unresolved, and this is having a dampening effect on the pound. GBP/USD is trading around the $1.2880 mark, which is approx. 120 pips below the high from 21/10. The fate of Brexit and the pound have been closely linked since the UK voted to leave the EU in June 2016. It is an interesting exercise to rank the Brexit process based on what the pound is doing. Although GBP/USD has backed off of its highs, it remains fairly well supported, which suggests a couple of things: 1, the FX market continues to see a no-deal exit as a low probability, 2, that the Brexit deal that was passed by Parliament will be the guiding light that leads us out of the EU. The pound has fallen some 60 pips so far today, however, we believe that this could be reversed, especially since news has broken that the government remains divided about having a general election, which could also reduce the chances of a no-deal Brexit. The EU is expected to confirm the UK’s Brexit extension tomorrow, and this may also boost the pound as we move to the end of the week. 

The case for further pound strength 

While GBP’s upward trend has been paused, largely because of the multitude of options that could happen over the coming months - election, no election, extension, no extension - we continue to remain upbeat about the pound’s prospects, as we believe that the chances of the UK leaving the EU without a deal remains extremely slim. This could continue to boost the pound as we move into the end of the year, and we may see a wide range in GBP/USD between 1.2800- 1.3500 in the coming months. 

Q3 earnings round up so far: don’t get too excited 

Elsewhere, stock investors are trying to make sense of the glut of earnings releases for Q3. So far, more than 15% of companies listed on the S&P 500 have reported earnings. At this early stage, 34% of companies have reported earnings that are above estimates, however, companies have reported earnings that are 2.6% above expectations, which is below the 5-year average. The picture is pretty similar for sales figures, so, even though corporate results are better than expected, they are still not good enough. 

Positive surprises in the financial and healthcare sectors have been neutralised by weakness elsewhere, including the energy sector, according to Factset. Right now, earnings remain on course for a 4.7% decline for Q3, which, if correct, would mark the first time the S&P 500 has reported three straight quarters of declines since 2016. This explains why the S&P 500 hasn’t jumped above the 3,000 level and extended gains into record territory – investors who are clued up, remain worried about the prospect of an earnings recession in the US, which could weigh on stock prices in the future. Thus, while it is tempting to trade stock indices on the back of better earnings for Netflix or Tesla, it is probably wise to trade the individual stock, rather than the broader index at this stage.