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UK Government faces confidence vote

By David Morrison  |  16/01/2019 15:56
”confidence

PM Theresa May suffered the biggest Parliamentary defeat in history and her government now faces a vote of ‘no confidence’. Yet the British pound is holding up well against the US dollar and euro
 
Following last night’s crushing defeat in Parliament over the European Union withdrawal agreement, Theresa May’s government now faces a ‘no confidence’ vote called by opposition leader, Jeremy Corbyn. Mrs May is expected to win with Tory rebels and the DUP all ready to rally round to ensure that the ongoing Brexit debacle doesn’t result in a fresh General Election. Despite all the ongoing shenanigans, sterling has held up remarkably well. It may not be the consensus view amongst political pundits and the news channels, but as far as investors are concerned, the likelihood is that the country is heading for a delayed or soft Brexit rather than no-deal. Part of the reason is that Mrs May, assuming she does survive tonight’s vote, has finally agreed to cross-party talks in an attempt to determine a way forward on Brexit. Many analysts are now making bullish calls for sterling, although that does depend on there being no chance of a no-deal Brexit. While the odds on this have lengthened, it’s also fair to say that there’s still no alternative to May’s original withdrawal deal. And whatever now gets cobbled together, it will not only have to pass through the House of Commons, but also be agreed by European policymakers. Nevertheless, if cable can consolidate above 1.2800 then a push back up towards 1.3000 looks possible.
 
US dollar strengthens
 
The US dollar continues to strengthen. This comes despite the Federal Reserve’s dovish pivot which helped to catalyse the sharp rally in global equity markets since late December. Overnight, investors were responding to a liquidity injection from the People’s Bank of China which sent the yuan sharply lower, and the dollar higher. China’s central bank injected 560 billion yuan ($83 billion) into the financial system through open-market operations, the biggest one-day addition on record. The euro also came under pressure after European Central Bank President Mario Draghi said that stimulus is still needed across the Euro area. Yesterday, Kansas City Fed President (and noted hawk) Esther George threw her weight behind a Fed pause in interest rate normalisation. She pointed out the lag between policy and effect and how this could lead to the Fed overtightening in the current environment. It was interesting that there was relatively little market reaction to her comments, suggesting that investors have fully priced in the expectation that the Fed will keep rates unchanged through the first half of 2019. The EURUSD briefly dipped back below 1.1400 and, in the absence of a bounce here, a retest of support around 1.1300 looks like a distinct possibility.
 
US Treasuries and the S&P
 
It’s worth noting that while we’ve seen an impressive bounce in US equity markets, we haven’t yet seen a large shift back out of US government bonds. US Treasuries rallied sharply as last year’s equity market sell-off accelerated. Investors rushed to buy up US government bonds as they were desperate to find safe havens amid the equity rout. Yet there has only been a modest selling of US Treasuries despite the sharp bounce in equities over the past three weeks. This suggests that investors are not entirely convinced by the current stock market rally and are anxious to diversify their portfolios. On one hand this implies that the equity market rally could run into difficulties as it approaches some significant levels of resistance. But on the other hand, if this rally continues, we could see a flood of money pour out of government bonds and back into equities. The S&P 500 is building on recent gains and consolidating above 2,600. However, this rally has come on disappointing volumes. So, as can be seen from the chart, the next big test comes as the index approaches the 50-day moving average and the 50% retracement of the October-December sell-off around 2,630. If it struggles and fails to break above here, then we could get a sharp reversal.
 
 
 
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