Will they, won’t they get a trade deal in time, and why central banks continue to prop up financial markets

As we move towards the end of the year there are some contradictory forces driving financial markets. Stocks and other risky assets continue to rise, with the exception of the FTSE 100, on the back of news that a potential $900bn fiscal stimulus is in the pipeline for US households and that two Covid vaccines have been approved for use in the US. However, a quick and efficient rollout of the vaccine could lead to a less dovish Fed in 2021, yet right now financial markets love the dovish Fed, which is why IPOs are surging and US stock indices continue to rise to fresh highs even as the jobless rate is surging in the US. Not even uncertainty around the Brexit trade deal has knocked financial markets off course, which should worry even hardened bulls as there is, as yet, no certainty that a deal will be reached before the January 1st deadline. 

Why so bullish? 

It seems like risks are mounting for financial markets, yet it seems like it will take a major catastrophe to knock the bullish sentiment that is dominating financial markets right now. As we have mentioned time and again, the reason why stocks are high is because US Treasury yields are so low, in fact yields all over the world are low right now, Spain’s 10-year bond yield is in negative territory at -0.01%. The hunt for yield is on, which is why stocks are surging, risky asserts are the best, and only, return around in the current environment. It also explains the fevered initial public offerings that we have seen in recent weeks. This was evident with Airbnb, which saw its share price surge when it listed last week, prices dropped more than $40 earlier this week, however, the naysayers were wrong: Airbnb’s stock price has recovered more than half of these losses and the week isn’t even over yet. While Airbnb may not be back at last week’s high, there is still decent demand for overpriced IPOs right now, and we don’t see that changing until the Fed changes its tune. 

Eternal optimism over the EU/UK trade deal 

So, economic data, and weak employment data in particular, don’t seem to matter to markets for now, however, surely traders care about Brexit and the uncertainty around a trade deal? The pound surged vs. the USD on Thursday and is at its highest level since April 2018, just below $1.36. This is a broad-based rally, and GBP is higher versus the euro, EUR/GBP is down some 200 points this week, as the market prices in the prospect of an 11th hour trade deal between the EU and the UK. The market has barely reacted to the news that the British prime minister is still warning that we need to prepare for no trade deal being reached in time, and there were similar negative sentiments coming from the European camp late on Thursday evening. This barely knocked GBP/USD, which fell back a touch to $1.3575 at the time of writing. 

Brexit losses its hold on the pound 

So, why is the pound, which has been so sensitive to Brexit news over the last 4 years, barely reacting to any signs that a trade deal won’t be reached in time? It could be Brexit fatigue or resignation that we’ve already left so what will be, will be. It could also be optimism that an 11th hour deal will be reached. The sticking point seems to be fisheries, which is a very small part of the EU and UK economies. On economic logic, surely both sides wouldn’t scupper a deal of this size on this relatively small industry. However, fishing is incredibly symbolic in the complex relationship between the EU and the UK. We have spoken about this before and we would also mention that fishing rights was the last thing to be agreed when the UK first joined the EU in 1972. So, while we can’t rule out no deal at this stage, we do think that the wrangling about fisheries is part of the age-old argument between the EU and the UK, and no side wants to lose face. We still put the chance of a deal above 90% and due to this we could see GBP/USD continue to rally back towards 1.36 and beyond in the next few days. However, we would urge caution, as GBP could sell off once a deal is confirmed at the start of the New Year, and GBP’s “Santa rally” could be a classic case of buy the rumour, sell the fact. 

As we move into the last two weeks of the year, the pound is in demand, and so are risky assets. We do not expect any major change in these themes in the short term.