Macro-Nutrients: Brexit, A Neutral Rate & The Trump-China Face Off at G-20

Brexit 2.0 – Big Implications. Big Obstacles As Well…

Over the weekend, the EU and U.K. finally came to an agreement on the draft terms for the U.K.’s exit from the EU according the Wall Street Journal (soft pay-wall). However, this is still a preliminary step: there is much more that needs to happen in favor of Brexit. Risk of no-deal within the U.K. Parliament remains extremely high despite cabinet backing.

Internal disagreement still lies within the Labor Party and the Brexiteers. There is no set date for a parliamentary vote – however, there are talks that it could be in early December.

One of the biggest challenges continues to be securing support – parliamentary approval – with the future of the Irish border and trade membership with the EU still some of the stickiest points.

Deutsche Bank’s Global Strategist Jim Reid said, “For the EU, the gamble is to offer nothing and assume the U.K. Parliament eventually offers a second referendum and voters eventually decide to stay. This increases the risk of a cliff-edge hard Brexit but also one where no Brexit happens at all.”

The European Central Bank met over the weekend where the meeting’s minutes revealed that even with the uncertainties surrounding the U.K’s potential exit from the EU, and despite recent weak economic data, the majority of ECB members feel that there should be no change to current monetary policy. It also noted the economy is experiencing “broad-based expansion” with an unlikely potential rate hike next year. Market implied probabilities of the ECB raising rates in February 2019 is currently around 20 percent, though according to Bloomberg, it was 11.1 percent last week.

Source: Bloomberg L.P.

Why It Matters:

In a seemingly likely messy Brexit outcome, the Bank of England could face a similar sell-off to the one it just experienced; inflation could sky rocket, triggered by a sell-off in the pound, while demand slows. In that kind of scenario, raising rates could be a mistake.

BI Economic Research reported: “In the case of a deal, the economy should perform as it has done over the recent past and the BOE will slowly push interest rates higher. However, if no deal, growth is likely to slow sharply and the economy will flirt with recession. We think the central bank would cut rates. Expect a significant repricing of U.K. assets whatever the outcome of the talks.”

What’s New With Trade Talks? We’ll Know After This Weekend

Aside from the ongoing tariff battle between the U.S. and China, any new news about a potential resolution has been anecdotal with all the focus on the G-20 meeting this weekend.

Last week, President Trump injected optimism on the trade policy front telling reporters China wants to make a deal and that he may not institute further tariffs. China has apparently offered a list of potential concessions which will be the basis of a trade deal at the Nov. 30 G20 summit.

On Nov. 16, Vice President Mike Pence delivered some sharp rhetoric on China in a speechat the Asia Pacific Economic Cooperation summit and said, “We have taken decisive action to address our imbalance with China…the United States, though, will not change course until China changes its ways.” He also added that the U.S. was in no rush to end the tariff war with China and in fact, would be willing to double its tariffs until there is cooperation from Chinese President Xi Jinping.

Additional comments on Nov. 22 from President Trump provide a more optimistic tone regarding a Chinese trade agreement with the G-20 meeting in Argentina this week. In a recent press conference, Trump commented saying he believes China “wants to make a deal and we’re very happy with that” according to Bloomberg.

There are some conflicting messages coming from the White House regarding the future of the U.S. relationship with China. However, this weekend’s G-20 meeting in Argentina will hopefully shed some much-needed light on the future of U.S. trade policy.

The Road to Neutral: Once Again… All Eyes on the Fed

The Fed raised interest rates three times this year with one more quarter-point raise likely next month. According to the Fed’s target of 3-3.25 percent, three more increases will follow in 2019. With evidence of a global slow down already underway, the markets are considering whether the Fed’s initial target was a bit too optimistic.

Over the past several weeks, the markets have significantly scaled back their expectations for future rate hikes next year. The futures markets are now only pricing in one Fed rate hike next year (down from three quarter-point raises forecasted in September) according to a recent Bloomberg article.

The Fed has much to consider regarding monetary policy heading into 2019.

The potential of a neutral Fed funds rate remains relevant, however, recent anecdotal evidence from Fed members over the past few weeks suggests a neutral level in rates is a much more likely reality heading into next year.

  • In a recent interview on CNBC, Fed Vice Chairman Richard Clarida discussed the global economy and said there “is some evidence it’s slowing” and interest rates are “close to the neutral range.” (TheStreet)
  • That same day, Chicago Fed President Charles Evans said it “makes a lot of sense to at least get back to neutral and then see how we are doing” at the Fixed-Income Forum Roundtable in Chicago (Reuters). 50bps in future rate hikes were removed after the comments according to Deutsche Bank.
  • Fed Chairman Jerome Powell spoke positively about the U.S. economy in a recent speech and downplayed concerns about volatility in U.S. markets however still hints at a more dovish tone. “So, you know, a good example is – a noneconomic example would be you’re walking through a room full of furniture and the lights go off. What do you do? You slow down. You stop, probably, and feel your way” he said during a speech at the Dallas Fed on Nov. 14.
  • “I don’t think we are too far from a neutral policy.” – Raphael Bostic, Atlanta Fed President said in a recent speech.
  • At this point, I’m not convinced a December rate move is the right move, but I need to watch the data over the next few weeks before determining whether it is prudent to boost the cost of borrowing again.” recently commented Patrick Harker, Philadelphia Fed President.
  • In an interview on NPR last week, Minneapolis Fed President Neel Kashkari said, “Right now, the U.S. economy seems to be the strongest engine of the major economies around the world – is that going to last, especially if the Fed keeps raising rates? It’s hard to know.”
Source: MarketWatch

What’s more interesting is the growing divergence between the Fed’s dot-plot and the market’s implied probability – who has it wrong? As shown above, the market now thinks interest rates are more likely to remain below three percent - implying that only one rate hike next year could be the silver lining. It’s a big week for comments from Fed members which will likely provide more insight on the Fed’s direction given recent economic data and ongoing weakness abroad.

For more on Brexit, see yesterday's article, Brexit Update: What's the Deal?

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