BNY Mellon: Market Drivers

BNY Mellon: Market Drivers

Outlook China United States Eurozone

By Simon Derrick, Chief Currency Strategist

By Simon Derrick, Chief Currency Strategist

Trading on Thursday and Friday provided an interesting insight into where the market is focused right now.

Coming out of last Thursday’s ECB meeting, probably the best thing that could be said about risk sentiment is that it remained cautious.

This began to change a couple of hours after the New York close following the publication of the story in The Sun that Northern Ireland’s Democratic Unionist Party (which props up the UK’s Conservative government) had agreed to support the prime minister's proposed next steps in the negotiations on withdrawal from the EU when they are put to a vote this week in the House of Commons - provided, that is, one key provision was made.

This proved to be almost exactly the point that rallies emerged in US equity futures, AUD/JPY, 10-year Treasury yields & other barometers of risk that lasted well into the European morning.

Given that the proviso reportedly made by the DUP was that the government’s proposals would need to include a specific time limit to the Irish backstop it’s arguable that investors might have drawn a little too much optimism from this headline.

Certainly the EU’s chief negotiator had told German public radio earlier on Thursday that the "backstop" provision in the withdrawal agreement negotiated with the EU cannot be time limited, since that would defeat its purpose of guaranteeing no hard Irish border.                        

Whether or not the story ultimately proves significant or not remains to be seen. However, what it did help illustrate is the impact that Brexit headlines continue to have on broader sentiment (perhaps driven by memories of the summer of 2016).

This, in turn, highlights why this week could prove a particularly volatile one for markets, given that it sees not just the vote in the UK’s House of Commons of January 29 but also the FOMC meeting, NFP data and a visit to Washington by Chinese Vice Premier Liu to discuss trade (all coming in the last full trading week before the Chinese New Year holidays).

The impact of Brexit headlines on broader market sentiment stands in contrast to the relative lack of interest being generated by the continued signs of a slowdown in Europe and the outlook for ECB policy.

Although it’s true that last week’s ECB meeting generated a modest amount of volatility, this was very modest when compared to that generated by other ECB meetings in recent years.

This pattern was also apparent on Friday morning with poor Ifo survey readings and a downward revision of the German government’s 2019 GDP growth forecasts barely stirring the market.

It’s entirely possible that this pattern might change over the next two months. Indeed, it’s worth recalling that in the first half of 2014 realized volatility in EUR remained incredibly muted, even though it was apparent from May onward that the ECB was preparing to do something.