By Simon Derrick, Chief Currency Strategist, BNY Mellon
- Trade war concerns are ebbing
- At risk European markets appear calm
- UK remains the most likely potential cause of market shocks
The market’s response to the latest trade war developments yesterday and today has been notably muted. While the CSI300 and TOPIX indices opened weaker yesterday and saw further losses early on, both have managed to stage rallies since then. This suggests that the market is becoming immune to the trade war threat. The question, therefore, is whether any other political stories could disturb the summer calm.
Over the past two decades, Chinese currency policy has proved a key element in both soothing market jitters (1998 stands out) and catalyzing broader market unrest (August 2015, most obviously). The weakness seen this week over the course of this week in both the CNY and CNH could therefore be seen as the precursors of of volatility to come. However, it’s worth recalling the pretty direct warning last week from Guo Shuqing, Communist Party Secretary of the People’s Bank of China, that “in recent years, some international investors have tried to earn big profits by shorting the CNY. However, the facts have proved that they misjudged the situation”.
This implies that China isn’t that interested in entering a currency war with the US right now. This, in turn, suggests that the PBOC will likely fight back against sustained CNY weakness. As a result it seems relatively unlikely now that Chinese currency policy will prove a cause of market unrest this summer.
Turkey might also be seen as a catalyst for potential wider market volatility. However, it's noticeable that the heightened concerns that emerged earlier this week have so far failed to spill over into broader market unrest. It's also noticeable that the TRY has actually managed to stage something of a comeback this morning.
With nothing particularly stirring in European markets that might potentially at risk from political developments (Bund/BTP spreads are stable just below the late May wides while both EUR/HUF and EUR/PLN are relatively calm), the most likely source of potential unrest in the next few weeks remains the UK.
With six Conservative MPs having already resigned from the cabinet since Sunday and talk of a resignation a day over the next two weeks, attention could start shifting towards whether the PM stands any chance of getting the final Brexit deal agreed with Brussels through Parliament when it comes to a vote later this year.
If the answer is no, then the issue will be whether or not she is prepared to go to the country for either a second referendum or another general election.
Regarding the former option, this would require Parliament to agree to a referendum (Labour’s deputy leader has said the party could support this option) and the questions to be asked of the electorate.
This could itself prove a thorny issue. It’s also possible that the country would vote for a second time to leave the EU, assuming that this question was asked on the ballot.
Regarding the latter option it’s possible that calling a general election after a defeat in Parliament on the Brexit deal would risk damaging her already weakened public image. If so, it’s even possible that the PM could decide that the best of a number of bad options would be to go for an early election if for no other reason than to seize the initiative.
Whatever the case, it’s also clear that the market does not consider any of these possible outcomes as being a serious possibility given that ATMF implied volatilities for both GBP/USD and EUR/GBP remain subdued.