Brexit – Now Comes the Hard Part

Phase One of the Brexit negotiations – the divorce settlement – has been completed, although the details of the special border arrangements for Northern Ireland have yet to be worked out, this is unlikely to be a smooth process. Moreover, the outcome represents a series of retreats for the Brexiters, writes John Llewellyn and Russell Jones of Llewellyn Consulting. Phase Two, which will lay the foundations for a final trade agreement to be negotiated in the transition period from 30 March 2019 onwards, will be deeply complex and contentious, especially on the issues of services, the status of the City of London, agriculture, aviation, and several other sectors. The risk remains of breakdown, of Mrs. May and her government falling, and of its replacement with a hard-left Labour administration led by Jeremy Corbyn, and all the additional uncertainties that entails, Llewellyn and Jones argue. Meanwhile, the British economy has already slowed, slipping from the front of the G7 pack to the back, while a combination of uncertainty, lower net inward migration, and the threat of reduced trade openness is putting the UK’s already denuded growth potential under further duress. This is a thankless period to be making policy. There is a high risk of error, and reversal, they conclude. Developments to watch include importantly: continued political disarray; yet weaker growth; additional budgetary overshooting; more sterling weakness; escalating ‘buyer’s remorse’ on the part of the Brexiteer public. Finally, the principal tail risks are: a breakdown in talks; another general election; a second referendum; 1970s-style chaos. Llewellyn, will be conducting its third roundtable in the series Brexit negotiations – the EU27 perspective on January 19th, in London. The core group of speakers will include Poul ChristoffersenDeclan KelleherAlexis Lautenberg, and Alex Barker – all with a thorough knowledge of the ongoing negotiations and the EU position. The briefing will be chaired by Peter Ludlow and John Llewellyn.  These briefings provide content not readily available anywhere else, as well as a highly-informative and open discussion among the speakers and the participants. A special rate is available to all Substantive readers. Click below to enquire.


UK: Wave Bye-Bye to inflation

The UK’s November’s 3.1% inflation reading will prove to be the local peak, according to BAML. They see inflation of 1.7% by the end of 2018, because the Sterling passthrough effects are fading. Furthermore, non-energy industrial goods inflation has slowed and pipeline pressures have weakened. Thus today’s inflation print has minimal implications for the BoE in their view. BAML clients can read the full note on BAML Markets.


Questionable US Tax Reform Could Create Headaches for the Fed

The effective tax rate being paid by US corporations is significantly below the current statutory rate, thereby raising questions as to whether the proposed statutory rate reduction needs to be so aggressive, writes Said Desaque of Desaque Macro Research. This notes asks 4 key questions: 1) Is a corporate tax cut really necessary? 2) How generous are the impending reforms? 3) How different are these reform to the last time there was a major tax cut; 1986? 4) Could the cuts create a major headache for the Federal Reserve? The note can be purchased on ResearchPool, alternatively you can contact the provider directly.


All Inflation Indicators Flashing Red

One of the issues bond investors will be grappling with in 2018 is the prospect of higher future inflation, writes Joe Kalish from Ned Davis Research.  In fact, for the first time since NDR put its Bond Bear Watch Report earlier this year (consisting of a list of key fundamental indicators it watches for signs of a turn in the bond market), all of the inflation indicators are flashing red, thereby meeting one of the four criteria needed  to declare a bond bear market. But the inflation risk premium still remains in negative territory, the report says.  When bond investors finally decide that they need a higher premium for the inflation risk they are taking, the term premium will begin to normalize and bond yields will climb higher. But when? Click below to request access to NDR’s Bond Bear Watch Report.


The UK and Irish Question: The Impossible Trinity

Early last week, Lombard Street Research warned their clients that the negotiations on the Irish border problem might collapse – to the detriment of sterling. They also predicted that the more likely outcome was a fudge. As it turned out, those were not mutually exclusive alternatives, LSR say in this report. The events of Friday morning have brought both things: negotiating collapse on Monday, and Friday’s fudge. As regards this fudge outcome, LSR’s forecast was that it would still threaten the UK’s minority conservative government that is propped up by the Democratic Unionist Party (DUP). Rather than being imminent, that threat – and here is the change – now looks more like a time bomb. The next big question is the length of the fuse. The UK is now committed to an impossible trinity. If you would like access to this report click below.


ECB: Life Behind the Curve

With the Eurozone economic data continuously showing positive signs, the SG cross-asset team assesses whether the ECB should still be loosening its policy stance. How far behind the curve could the ECB safely go, and why? Regarding the increase in monetary accommodation, it is currently unclear whether the ECB is behind the curve in terms of tightening, writes SG. However, there are good reasons to take a cautious approach to ending QE. But there is also a risk that the ECB drifts behind the curve and eventually has to tighten faster than the markets, boosting asset prices at a relatively late stage of the economic cycle, while also wasting ammunition that may be needed in the next recession.  SG doesn’t expect any substantial information in next week’s meeting, but a GDP growth upwards revision and inflation to be on target for 2020. SG Clients can read the full not via the bank’s research portal.


Brexit: Tentative Divorce Deal May Unravel in Phase Two

Theresa May’s task of navigating Brexit is about to get much tougher and much sooner than most realize; the Government faces a potential Commons rebellion on the Withdrawal Agreement next Wednesday and she has also conceded to a difficult Cabinet debate on the end-state before Christmas. That said, the draft EU27 guidelines issued early this morning already largely prescribe the landing zone of any future UK-EU free trade agreement—essentially Canada, with no real potential on services. This will present risks to the divorce agreement reached this morning next year: Tory Eurosceptics will likely only stand-by the concessions in today’s deal if they like what they are getting on trade, which they won’t, the report concludes. Click below if you would like access to the full report.


How US Tax Reform Changes the 2018 View

Since Trump was elected over a year ago, the J.P. Morgan view has always been that Congress would pass decent-sized tax cuts (about $1 trillion net over 10-years), but that tax policy meant more for equity market returns than for US growth, Fed policy and most fixed income markets (rates, credit, currencies and commodities). They’ve published several dozen research reports since then that detail the rationale for this view (all available on Morgan Markets). As they wrote in this report last week, it is the rationale – rather than the forecasts and trades – that often matters more for clients and so this note recaps the framework for those considering their own 2018 asset allocations and hedging decisions. But they have included a really useful table within the report that outlines what has stayed the same across that asset classes, and what has changed the most. We can only highlight a few here, and for bonds this would includes faster Fed tightening (4 hikes) and the highest % of DM/EM central bank tightening since 2007. For equities, lower returns than in 2017, and better returns in Europe and EM than in US. JPM clients can view the full note on Morgan Markets.


Will Banxico Raise Rates this Week?

TS Lombard have a very strong and experienced LatAm research team who are just back from Mexico City where they met with officials at the Hacienda (Ministry of Finance), Banxico and many other economic and political contacts they have there. This is a very thorough and complete report, where they look at the performance of the economy, monetary policy and the new head of the central bank, their outlook for next year’s election and NAFTA. Their key takeaway is that restrictive monetary policy and the NAFTA renegotiation remain the main risks to growth in 2018, while for NAFTA their base case is the likely preservation of the trade deal, but any unexpected shocks such as an outright withdrawal would favour AMLO’s candidacy. As for monetary policy and this week’s rate decision, TS Lombard’s base-case scenario is that the bank will keep its policy rate on hold for most of next year. Barring any big shocks, the first movement is likely to be a cut in the bank’s rate in Q4/18 – once inflation edges closer to the bank’s target. Click below if you would like to get access to this comprehensive report on Mexico.


Time for Fed to Spread Some Christmas Cheer?

Since June, there has been an alarming drop off in the amount that households are saving each month, despite evidence of some improvement to disposable incomes, writes Keith Grindley from Macro Thoughts. If households suddenly feel the need to build up theirs savings again in 2018, and with inventories already high, consumer spending (2/3 of GDP) could hit growth in the first quarter, or even the first half, of 2018, which could see GDP below 2½%, the note says. Therefore, Grindley argues that as the Fed prepares to raise interest rates this month they should also start to show signs that they are willing to compromise on rate increases during 2018 and become more data dependent. If markets were to see such overtures, then Grindley thinks short positions in Treasuries may be forced to be closed, and the curve would likely to steepen. Click below if you would like to request access to the full note