The U.S. dollar traded higher against all of the major currencies today with the exception of the Canadian dollar because as it turns out, the U.S. government shutdown has been good for the dollar and stocks. Outside of the decline on the first day of 2019 trade, there has not been a down day for the Dow or S&P. But don’t mistaken the government shutdown is not actually positive for U.S. assets. Instead, it is the delay of U.S. government releases that gives the market relief. No news is good news. The short list of data that has been released was not entirely negative, but there’s no doubt that the trend of growth is lower. While manufacturing activity improved in the Philadelphia region, activity eased to its lowest level since May 2017 in the NY area. Producer prices dropped less than expected but declined for the first time in 4 months. Consumer confidence also hit a 2 year low according to the University of Michigan which is concerning because sentiment has a direct impact on spending. Major reports such as retail sales and the trade balance have been delayed due to the shutdown and while government shutdowns don’t tend to inflict lasting damage on the economy, its never gone on for this long. Now in its fourth week, the shutdown could take more than 0.5% off growth as 800,000 government workers who are not getting paid reduce spending and investment.
But the stalemate could end soon as the Trump Administration grows anxious. Tens of thousands of workers are being called back to work and are promised that they will be paid for at least one pay period. Unfortunately the White House has shown no signs of relenting with Trump hitting back at Pelosi’s call to delay or cancel his state of the Union address by canceling her trip to visit troops in Afghanistan. Its not clear how long much longer President Trump will put the economy and the country in limbo through his attempt to strong arm the Democrats in providing funds to build a border wall. If the stalemate ends and the government reopens, the US dollar will rally but if it continues, USD/JPY will take its cue from risk appetite while other major currencies react to local data. The Bank of Japan has a monetary policy announcement this coming week. No monetary changes are expected but the central bank could lower its 2019 inflation and growth projections.
Meanwhile sterling fell sharply on Friday ahead of the government’s release of Plan B. After surviving a no-confidence vote Prime Minister May is now required to present a backup plan to Parliament by Monday. Before we get to the possible options, sterling’s reaction to further Brexit uncertainty has been remarkable. Instead of falling, it hit a 2 month of 1.30. As the market ruled out a victory days before the Brexit vote, the recovery in GBP reflects expectations for the extension of Article 50 and the diminished possibility of a no deal Brexit.
Taking a look at the options for plan B, May really has no choice but to ask the EU for more time, which is why by Monday, Article 50 should be extended. It then goes to vote by EU member states who are widely expected to approve the request. However it won’t be an open ended extension. The European Parliament’s Brexit coordinator Verhofstadt suggested that he’s open to an extension to May and not beyond that because he doesn’t want Brexit opinions to spill over to European parliamentary elections. But an extension can’t be the only element of Plan B. May will need to decide what course to take in the coming months – either a Norway style model or a permanent customs union or relent to a second referendum – all of which should be positive for GBP. However, after winning her no confidence vote, May made it clear that leaving with no deal cannot be ruled out. Although unlikely, if she does not request for an extension, paving the way for a no deal Brexit. GBP will crash even if Parliament responds by taking control of Brexit negotiations. After that, Parliament is scheduled to debate and vote on Plan B a week later on January 29th.
What is Plan B – 3 Main Scenarios
1) Delayed Exit Request > Leading to Norway style deal or permanent customs union
2) Delayed Exit Request > Leading to second referendum
3) No Delay Exit Request > No deal Brexit