Brexit talks 'drag' on, Dollar influence may take over this week

Wednesday, 5th September 2018 07:21 - by Shant

At the start of the week, UK assets are feeling the additional heat off the back of weakness in the PMI surveys, with both the manufacturing and construction sectors seeing their respective indices contracting. Naturally, connecting the dots clearly points to uncertainty over the Brexit negotiations, which saw new export orders contracting for the first time in 2 years in yesterday's report. 

We suspect the level of negative coverage over disruptions to supply chains will have been the major contributing factor, given recent Sterling weakness has been supportive in previous episodes.  This negative correlation is an important dynamic in the welfare of the UK economy, which has benefited from what has effectively been a pressure valve during the past 2 years.  

Tuesday's release saw the associated names in the FTSE hit hard - homebuilders were down led by the Berkeley Group down over 4%, double that of Barrett Developments which closed down 2%.  Persimmon and Taylor Wimpey both lost 2.5-3.5%. 

Now that we are nearing crunch time in the UK-EU talks, we will have to monitor this inverse relationship with Sterling more closely.  We still maintain the base case scenario remains that of some form of agreement being put in place in order to avoid a cliff edge EU exit, which would not serve in the interests of either side.  Even so, this is conjecture at this point, and having seen a number of worldwide events surprising us in recent years, assumptions carry much less weight in the current market, which looked at from a broader perspective, lacks conviction outside of the obvious draw of US assets including Treasuries, which have been prefered to the traditional safe havens of late. 

Losses on homebuilders were matched by names in the commodities sector at one stage (Antofagasta, BHP and Glencore all down by just under 2.0%) as raw materials were also under the cosh on Dollar gains. Dollar strength due to outflows from emerging markets has been driving prices lower, with the fall out in South Africa grabbing the headlines.  

However, the week ahead offers up plenty of US data on which to base the current positive outlook on the world's leading economy.  ISM surveys will be the more forward-looking, while at the end of the week, the jobs report will reveal whether lower unemployment is feeding into wages.  Growth here has been painfully slow, and if there is little feed-through despite tightening labour markets, one has to start focusing on the consumer impact on growth and whether it is sustainable beyond the pass-through of tax cuts initiated at the start of the year. 

Harking back to Jackson Hole last month, the Fed chair was clear in distinguishing the rate path with respect to the upcoming data.  Any softness in growth projections will dampen implied rates in the short end of the US yield curve, and remember at this stage, a fourth Fed rate hike this year is still in the balance as futures markets price this in by a little over 50% for now.  Given this month's FOMC meeting is widely expected to produce another 25bp increase on the Fed funds rate, it is hard to see the Fed missing an opportunity to normalise.  Consequently, the market will be quick to refocus on later in the year, so the supremacy of the Dollar and US assets may start to slip a little if this week's numbers do not 'add up'.

On this basis, if there is a widespread turn in risk sentiment - and let's not forget that seasonality (Q3-Q4) can be tough for equities.  If this is combined with a bout of USD weakness - and the midterm elections in the US are also a major risk here - then we expect the multi-nationals will be harder pressed than the rest, as USD based revenue streams could take a hit.  Outside of the mining companies, Mondi, SAB Miller and the Weir Group are among those who have the largest non-UK revenue.  For the mining companies themselves, any Dollar weakness would have to be reflected in a pick up in commodities.  We (have and continue to) watch Gold and Copper at the present time - the former having based out at $1160 recently.  We expect to see the yellow metal resume its safe haven status against the Dollar at some point and expect this to align with Fed 'repricing'.

Given the lack of Dollar follow through on today's strong ISM manufacturing numbers, we may start to see some of the more traditional correlations returning to the fore.  It has been a one way street in the market over the summer, though naturally, a saturation point comes eventually.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.