Daily Market Digest: Brexit Drama Continues

h2 Market movers today /h2

• It is a very quiet day on the data release front. Brexit will continue to catch the limelight with the Boris Johnson government trying to push through his Brexit law in the House of Commons in only three days. The big moment is around 20:00 CEST when the MPs vote on the general principle of the bill followed by a vote on the timetable for the rest of the bill. The bill is expected to survive the former but may lose the latter, which would make it very difficult for Johnson to leave the EU by 31 October. We still need to monitor whether there may be support for tweaking the bill in such a way that there is no longer support for passing the overall bill. In particular, focus is on (1) a confirmatory referendum and (2) a permanent customs union.

• The Hungarian central bank (MNB) is set to announce its monetary policy rate decision today. In line with Bloomberg and Reuter's consensus, we expect the policy rate to stay unchanged at 0.90%. The MNB's tone is likely to continue to be dovish on decelerating inflation but the recent Brexit deal has supported central and eastern European currencies, including the HUF. Thus, there is less pressure on consumer prices from HUF devaluation in the future.

Trade talk optimism continues to lift market sentiment and was further fuelled yesterday by positive comments from Donald Trump that talks over an initial trade deal are progressing. Based on the latest developments, we now set the probability of a deal at 50% from previously 40%. European equity markets advanced, as bank shares climbed with rising bond yields. The S&P 500 index surpassed the 3000 level and the risk-on mode seems to continue today with Asian equities and US index futures in the green.

A solution to the Brexit drama remains elusive, as PM Johnson struggles to get his deal over the finish line. The Withdrawal Agreement Bill was published yesterday and the focus in the upcoming debate (despite possible amendments on confirmatory referendum and/or customs union) seems to be on the MPs' power to ask for an extension of the transition period (clause 30), the MPs' power over the negotiations with the EU (clause 31) and workers' rights (clause 34). A key element is that some MPs fear that they do not have enough power to avoid a no-deal Brexit by the end of the transition if no permanent deal is reached.

European government bonds remained under pressure as the market concluded that the risk of a hard Brexit is now very small. 10Y Bund yields jumped 4bp to the highest level since July. Italian bonds underperformed after reports of renewed tensions within the governing coalition over amendments to the 2020 budget pushed for by the Five Star Movement. Last week the government submitted its budget proposal to Brussels envisioning a budget deficit of 2.2% of GDP for 2020 and a further deterioration in the structural deficit. That would require flexibility from the EU Commission, which is reportedly seeking some clarifications on the budget details. However, we still see the probability of another budget stand-off as low at the current stage.

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Scandi markets

No market movers in the Scandi countries today.

Fixed income markets

Ireland continued to outperform with the 10Y yield rising just 1.6bp. Investors continue to buy into the underlying strong Irish fundamentals and unwind short positions in Irish bonds that were put in place by investors as a hard-Brexit hedge.

BTPs underperformed yesterday as the Five Star Movement demanded significant changes to the budget, whereas PM Conte only will allow for smaller changes. However, we firmly believe that the budget will be finalised and that the EU Commission will accept it. We are not heading for a new Italian budget crisis. Furthermore, we expect that the more stable political outlook and the much lower funding rates compared to a year ago will convince Standard & Poor’s on Friday to remove the negative outlook when Italy is up for review and move the outlook back to neutral or even positive. Hence, we are very comfortable with our long 10Y BTP versus Bunds recommendation.

FX markets

The USD sell-off took a breather yesterday after Johnson failed to bring his deal to a new vote in the UK parliament. Focus may now gradually turn to central banks on Thursday and in yesterday’s FX Essentials we stressed that we are likely in for new year highs in USD/SEK if Riksbank opts for the dovish shift we look for. The SEK has strengthened the past couple of days, seemingly on positive Brexit-related headlines. However, we believe the importance of this will diminish come the Riksbank (Thursday): we expect at least a verbal intervention stating the hike will come in February rather than December. Most likely it will be accompanied by a shift in the repo rate path. Current pricing indicates +8bp in December (then flat), which is overly aggressive from our perspective. In other words, we see scope for a substantial repricing should the Riksbank start to quiver, which should be accompanied by a substantial move higher in EUR/SEK as well.

After a tough week, the NOK regained some lost ground yesterday on seemingly improved risk appetite and risk rallying. Meanwhile, with oil and gas prices down on the day and with domestic data falling moderately short of expectations, we rather think the move is a reflection of NOK weakness having gone too far last week (possibly driven by M&Arelated activity). One simple way to illustrate this, is our fair-value estimate based on relative rates, risk sentiment and the oil price, which currently suggests a EUR/NOK fair value of 9.93. We stay side-lined for now still until we see an improved performance of Norwegian terms of trade and/or global energy stocks performing.

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