U.S. equities were stronger Monday. The S&P 500 closed up 0.7%; U.S. 10-year Treasury yields were up 6bps to 1.88%. Equity markets continue reveling in the afterglow of a limited agreement on the Phase One trade deal at the end of last week. The better tone on Chinese data further propped investor sentiment, this despite a slightly softer-than-expected December read on the NY Fed's Empire State Manufacturing survey and the U.S. manufacturing PMI.
But the real stock market story was the market breakout across the pond. Last week a lot of the market's concerns were solved on UK politics, trade, and ECB, which all provide tailwinds for risk. That was until the pound got pounded!
Sterling
Sterling traders received the proverbial lump of coal in the holiday stocking after Boris Johnson heedlessly opened the door to a possible no-deal Brexit, which sent cold shivers down the spines of long sterling positions that are hoping for an amicable end to the UK-EU divorce proceedings.
Nothing could be further from the truth as PM Johnson is now looking to legally prevent Brexit from going past 2020 and said to make the promise to EU that the UK will leave but the end of January with or without a deal. Cliff edged Brexit here we come apparently.
But GBP overreaction in early Asia trade is the norm, not the exception, so a bit of caution chasing headline risk early in the session when liquidity is paper-thin on "Cable." Nonetheless, the market fell nearly 100 pips as traders dumped excess " poundage."
However, this could be a case where of where PM Johnson is borrowing a page from President Trump's negotiation and crisis management manual where a potential crisis is marched to the top of the hill so that he can march it back down again and claim victory? Without further escalation, the market could buy the dip initially, writing this headline off to political posturing as PM Johnson is trying to sweeten the deal with the EU.
A tactical mistake??
It was an incredibly strong day for stocks in Europe yesterday, the FTSE 100 was up over 2.5 % and the STOXX Europe 600 was 1.5% higher. Both markets continue to outperform the U.S. Whether European equities are set to beat in 2020 has been the raging topic of discussion with some suggesting they are, particularly given accounts, are generally perceived to be underweight. Indeed, much has been made about real money being underweighted UK assets. Maybe those much-touted inflows have started already throwing caution to the wind and not waiting for more certainty on the structure of the new EU vs. UK relationship. Could this have been a careless tactical mistake??
Friday December 20th is also the 4th Triple-Witching day of 2019 in the U.S., which should make for an exciting close to the week.
Oil Markets
Nothing like an unexpected risk wobble to open the day, but seldom if ever do things go as planned with Johnson and Trump manning the helm. Oil is trading a bit lower on the uptick in geopolitical uncertainty in the wake of PM Johnson's no-deal Brexit threat. Optimism on a phase one U.S.-China trade deal and robust China economic data have offset Friday's report of a U.S. rig count increase and some.
Oil prices are holding relatively steady. Still, price action has stalled as traders are not entirely convinced that the phase one trade deal is a significant enough economic game-changer to overcome the forecasted supply glut entering 2020. From an economic perspective, this limited deal also has limited effects on growth in the U.S., China, and indeed globally. In particular, the smaller-than-expected rollback of tariffs is probably not enough to boost global trade flows sufficiently to restore business confidence, and therein lies the fundamental issue for growth assets like oil.
Sure, U.S. tariffs on Chinese imports have been macro anvils that have weighed on oil for much of this year, so the removal of a small slice, from a risk perspective, will surely provide another level of downside insurance into year-end. However, the lack of clarity in the final details of the deal is a bit concerning for traders. Not to mention its utterly unclear under what conditions the U.S. may agree to roll back additional tariff hikes and when those reviews are going to happen.
Yes, we have taken a positive step, but risks remain high. Without a significant chunk of tariffs rolled back, the economic boost will be limited, hence so will the bounce in oil prices.
And while the OPEC agreement will provide a high level of downside insurance, the production agreement is structured to limit downside risk, and may not necessarily send prices higher. Saudi oil policy has been ineffective at raising oil prices in the past and not sure why this time will be anything different. From a purse speculator perspective, according to the IMM data, oil positioning jumped materially higher to 22% (from 20%) following OPEC's decision to reduce output quotas, along with a promise to tighten compliance.
So, with positioning a bit stretched, prices trading at three month high, and since phase one missed on the market's tariff rollback expectations, traders could shift into aggressive profit-taking mode on the first bearish hic-up on the inventory data. In the absence of a bullish catalyst, there is a risk of profit-taking into year-end that needs to be respected.
Gold
Gold prices have been slow to react to the negative Brexit headlines. But it should provide a stark reminder to investors that in times of uncertainty, especially with rates so low, gold remains the perfect hedge against geopolitical risk wobble, especially when the markets are entirely complacent to risk-off.
But gains will be limited given the Fed on pause narrative; without a dovish Fed impulse, explosive gains in gold will be limited.
Currencies
All the focus was on the pound at the open.
The dollar strengthened out of the gates this morning on safe-haven appeal after the threat of no-deal Brexit sullied the currency landscape. Traders will be very cautious chasing this headline, but price action and follow up headline risk will need to be respected.