Exhausting week ahead, as central banks, Brexit and Payrolls dominate

It’s not often that earnings season is pushed down the list of the market’s priorities, however that is the case as we move into the last few days of October. Instead, the market will be parsing decisions from the Bank of Canada, the Federal Reserve and the Bank of Japan, and two out of three are expected to cut rates. The FX market will also give its verdict on the latest from the Brexit saga, and to round things off, US payrolls, released on Friday, could see a further declaration in the US rate of jobs growth.

Brexit extension granted, now what? 

All eyes will be on the pound at the start of this week, as it reacts to news that EU leaders are expected to meet on Monday to agree to a 3-month Brexit extension until the 31stJanuary. If this does happen, then the immediate threat of a no-deal Brexit this coming Thursday will be taken off the table. However, the extension will mark the beginning of a tough period for the Prime Minister, as he tries to get Parliament to approve both his demand for a general election and the EU withdrawal bill agreed at the last EU leaders summit on 17thOctober. MPs are set to vote on a proposed general election date of 12thDecember on Monday, and as we mention below, this vote could be critical for sterling in the coming days. Interestingly, although the polls are suggesting that Boris Johnson could win a majority in a December election, which would allow his EU withdrawal bill to pass parliament and ensure that the UK leaves the EU with an agreement, the FX market is less certain. Perhaps the market is concerned about the fragmented nature of British politics or the surge in support for the Liberal Democrats and Brexit party which could derail a Conservative win. As we start the week GBP/USD remains stubbornly below $1.2850. 

The three conditions necessary for a sterling rally 

At the start of the trading session this Sunday, GBP/USD had a small spike higher, potentially on the leaked news that the EU will agree to a three-month Brexit extension. However, we believe that in the short term, the upside could be limited. The pound has drifted lower since peaking on 21stOctober, and the uncertainty about what comes next, even with an extension, could see enthusiasm for the pound dither. At this junction, a few things would need to happen for GBP to extend its recent rally back above $1.30 vs. the USD: 

1, Parliament would vote for an election (something to break the deadlock would be welcome by the FX market).

2, The polls would continue to point to a decisive victory for the Conservatives. This would add to the welcome feeling of certainty in financial markets, and the prospect of a business-friendly environment with a Conservative government at the helm could also boost sterling. 

3, The Conservatives win. Although a win for a Labour-led remain alliance could be a short-term positive for the pound as it could trigger a reversal of Brexit and the UK staying in the EU, the economic and monetary implications of a hard-left UK government is ultimately pound negative, in our view. 

For now, until we achieve greater clarity about what the UK parliament will do during this extension period until the end of January 2020, it is hard for sterling to rally, and we believe that any rally in GBP/USD to $1.2870-$1.29 could be sold. The FX market will want to see what the government has up its sleeve this week, and if the Lib Dem/ SNP proposal for an election helps Boris Johnson’s election vote on Monday to pass, then we may see a deeper relief rally for sterling in the coming days.  

Earnings fade into shadow as Fed meeting takes centre stage 

As we mentioned last week, earnings season has been a mixed bag, good news from the financial sector has been neutralised by some weak performances from the energy sector. Right now, the S&P 500 is still on course for a more than 4% decline in earnings over the third quarter, which would be the third straight quarter of decline since 2016, and is one reason why the S&P 500 has been making such hard work of life above 3,000. If this index is to move significantly above this level then the Fed meeting, which takes place on Wednesday, could be a bigger driver than corporate earnings. 

What next from the Fed? 

A rate cut by the Fed this week is fully priced In to the tune of 93%, according to the CME’s Fedwatch tool, thus we don’t expect the rate cut itself (if it does happen) to be a big driver of stocks or the dollar on Wednesday night. Instead, the Fed’s future intensions will be of more importance. This includes the updated dotplot and the Fed chair’s press conference after the decision is announced. The market is pretty convinced that there will be no further cuts to interest rates this year, and there is currently only a 35% chance of another cut to 150-125bps in January. Thus, it will take a dramatic shift in stance from the Fed to change market expectations that the US central bank will hold rates steady for some time after this meeting. This neutral stance could disappoint markets, thus we could see stocks fall and upward pressure on the dollar start to build, if the Fed acts as we expect. Any shock dovish tilt that boosts chances of a further rate cut in December or January could significantly boost stocks and push the S&P 500 comfortably above the 3,000 level. We believe that this is a low probability event at this stage and expect the S&P 500 to drift lower, back towards 2,800 by the end of this year. Read our mid-week report to get our analysis from the Fed, along with our NFP preview.