Brexit Rests on Backstop

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Market Drivers December 12, 2018
EU Summit and ECB on tap
Cable holds bid post-May’s win
Nikkei 0.99% Dax 0.06%
Oil $51/bbl
Gold $1245/oz.

Europe and Asia:
SNB Rates unchanged

North America:
EUR ECB Presser 8:30
USD Weekly Jobless 8:30

Cable was higher in early London trade today trading towards the 1.2700 figure after Theresa May managed to survive a rebellion within her own party and maintain the Tory leadership and the PM post.

She continues to face a monumental task of trying to pass her deal through Parliament, but with the vote now delayed until mid-January she has time to wring further concessions from EU. The whole Brexit deal now rests on the Irish backstop issue which essentially comes down to whether Northern Ireland will fall under EU rules in perpetuity or whether UK will be able to assert control over the territory sometime in the future. The crux of the matter revolves around the border between North Ireland and the Republic of Ireland which is completely open to trade and crossing as of now. May’s Brexit deal would not change that status for now, but the stumbling is whether UK will ever be able to assert its own policies over the border.

May’s argument has come to this – its the best deal UK can get and if Parliament does not approve it, UK will face a hard Brexit which could lead to the worst depression since the 1930s. So far the threat of doom has not worked on the hardliners in her party and it’s doubtful that even with some concessions on the backdrop front that she will be able to sway enough votes from her side to win majority approval. Assuming she gets some further concession from EU she will need at least some support from the Labor side, who may feel the existential threat by January.

From the EU side the issue is whether succumb to pragmatism with UK and abandon its principle of fully open borders within the union by agreeing to some timeline that would relinquish border control to the UK or to simply play real-politic with Ms. May, force a failure of her deal and hope that that UK opts for a second referendum in face of economic catastrophe. That is clearly the preferred path of Brussels, especially that it now has the legal cover from ECJ to allow UK to revoke Article 50 without any preconditions. But Europe itself is torn by the same populist forces that have upended UK politics. With France in the midst of riots, Italy squabbling over the budget with EC and Germany weakened by the slowdown in global trade, the officials in Brussels have to decide whether the nuclear option will be worth the risk. A hard Brexit will put the whole Continent into a recession and the Europeans clearly want to avoid that scenario.

For the time being markets continue to bet that cooler heads will prevail and that the UK will remain within the customs union in 2019, but the chaos and turmoil of British politics have undermined investor confidence and traders remain wary. Still, the rebound off the 1.2500 level is proving to be a positive sign for cable longs and if further negotiations suggest some progress – even if it is cosmetic in nature – the pair should continue to press higher on hopes of a Brexit solution.

Against this turbulent background, Mario Draghi will face the press today for the monthly ECB meeting. Conditions in the EZ remain weak, although the slowdown in growth appears to have stabilized. Still, the economic backdrop hardly offers a vote of confidence to ECB policymakers and it will be interesting to see if Mr. Draghi continues to maintain his hawkish stance and insistence on taper given the deterioration of data and the political turmoil in the region. EURUSD has struggled to bust through the 1.1400 level for the past two weeks and if Mr. Draghi tones down his rhetoric suggesting a more accommodative monetary policy the pair could quickly slide below 1.1300 as the day proceeds.

Boris Schlossberg
Managing Director

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