While everyone awaits the British Parliament’s decision on the proposed Brexit deal, European streets are erupting in anger. The voices of protestors in France are resonating elsewhere in Europe, and populism is back to dominating markets.
We have been underweight European equities and Euro exposure for the past year. There were good reasons behind our conviction, and we have been vindicated. The EUR/USD is finally getting its relief rally, and this one will likely extend further because of markets beginning to question the Fed’s resolve to raise interest rates much higher from here. When the EUR/USD was trading at 1.193, we wrote:
The Eurozone, by contrast, opted for “fiscal discipline” and imposed austerity on the masses of unemployed. And far from strengthening the Euro as most hard currency proponents forecasted, the result was the exact opposite. To put the EUR/USD rally in 2017 in perspective, this pair was trading above 1.50 in 2008. the excess capacity created subpar growth since 2008 hurt demand for the currency during this period.
Back then and now, the issue for the Eurozone remains the same. Austerity is the problem, and deleveraging through fiscal discipline has reached its political limits, with France’s working class resorting to violence as they have, the leaders in Europe will be reminded that they are still vulnerable to populist movements. We would not be surprised to see these protests spread to neighboring countries with similar issues in the same way the Open Wall Street movement spread throughout the developed world.
One Day More
As we watched the debate in the British Parliament, it became clear to us that there is no possible happy ending to the Brexit negotiations. There are too many factions opposed to the deal in its current form. On the other side, Brussels will predictably lack flexibility as it has on every other issue threatening the EU’s existence. With French politics boiling over and Italy’s budget challenge, Brussels is much weaker than it was a few months. There is no certainty in this equation, and European markets will remain treacherous to navigate in the coming months.
To understand Brexit, we urge our readers to watch the British Parliament proceedings. Our immediate decision point will be Tuesday’s vote on the proposed Brexit deal:
1. Theresa May risks the vote, and Parliament rejects the Brexit deal.
2. Theresa May risks the vote, and Parliament accepts the Brexit deal.
3. Thresa May delays the vote until a better agreement can be reached with Brussels.
After listening to Corbyn’s speech and seeing the DUP’s open rebellion against Theresa May, we see the first scenario as the most likely outcome. What follows will be a challenge to May’s government that could potentially end up in Corbyn running the country. We do not believe the markets have fully discounted probabilities of this scenario.
As the US dollar’s yield curve is fighting inversion, the Chinese yuan’s is steepening. What this means is that markets are pricing in higher inflation and higher rates expectations in China. This is a good sign, and it confirms what we have been writing about for weeks with respect to the opportunity to deploy to Chinese equities before the fiscal stimulus works its way through the Chinese economy in 2019.
Headlines of a trade war cease-fire were quickly muffled by political friction after Huawei’s CFO arrest. China summoned the US Ambassador this morning, and concerns that this dispute will spill over into the trade negotiations are driving Chinese equities lower. In spite of this negative development, we maintain our conviction in Chinese equities and do not see any significant impact from the Huawei case.
The Week Ahead
The UK, Russia, and Ireland report GDP, and inflation figures are due out of US, Europe, India, Argentina, Hong Kong, and Saudi Arabia. India’s trade balance should give some indication on the direction of the INR. Eurozone, Switzerland, Norway, Russia, and Brazil are all announcing rates decisions, and none are expected to change policy rates this time.
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