As the US government shutdown continues, it appears to be dragging on the USD. The DXY index is starting to fall more than it did during other government shutdowns.

That may be because this one has already dragged on longer than the others, and it shows no signs of being resolved. The uncertainty is a drag on the dollar. So too is the hit to the economy – it’s no small thing that 800k workers aren’t being paid. Imagine what the impact on the markets would be if the monthly nonfarm payrolls suddenly fell 800k.

Of course, the change in tone at the Fed is also a problem for USD. Fed Chair Jerome Powell recently summed up the Fed’s position as, "we’re in a place where we can be patient and flexible and wait and see what does evolve, and I think for the meantime we’re waiting and watching." “Waiting and watching” is very different from the 1-rate-hike-a-quarter schedule that they were basically on last year.

You can see how the comments from the various Fed officials have changed the market’s view on rates since after the December FOMC meeting. Investors now see only a 17% chance of even one rate hike during 2019, even though the FOMC themselves are predicting two hikes this year. Also note how the curve declines over time – apparently, investors expect the US economy to slow over the year and think that if the Fed doesn’t manage to raise rates in the first half, it may well lose the chance to do so at all during the year.

On the other hand, note too that the probability of a rate hike this year has risen slightly over the last week despite the many dovish comments. Still, it remains distinctly improbable. Indeed, the market places a higher probability of a rate cut by Jan 2020 than a rate hike (23% vs 15%).

Meanwhile, the big crisis in the Eurozone – the fight over the Italian budget – has been resolved successfully, leading to stability in peripheral bond yields. This recovery in confidence in the EU, compared to the chaos over in the US government, should keep EUR/USD well underpinned.

Although I have to admit – if we look at the Baker, Bloom & Davis indices of policy uncertainty, European policy uncertainty is greater than US uncertainty and the gap was widening as of last month. I can only surmise that this was affected by the Italy brouhaha and once the January data is out, the trend will reverse. (BBD doesn’t put out a weekly index for the EU.)

This week: the Brexit vote!

Have you ever heard the saying, “today is the tomorrow you worried about yesterday?” Well, this week is the week we’ve worried about for the last two years: the week the UK Parliament votes on Brexit (Tuesday, probably).

I’m not going to go into much detail about it, for two reasons: 1) it’s incredibly complex, and 2) you can read much better, more thorough discussions about it in many places on the internet. Suffice it to say that I (and everyone else, I would imagine) expect that they won’t pass the bill. In that case, the government has three days to come back with a Plan B. They couldn’t come up with anything better than this in two years, so how are they going to improve on it in three days?

The outlook is clouded by the fact that the Labour Party head, J. Corbyn, wants to leave the EU too, so he’s probably secretly in favor of crashing out with no agreement. He may therefore decide just to let nature take its course. Or he could call a vote of no confidence in the government, which might result in a general election, probably in April. Or May could resign and they could call another election. Or somehow, they could hold another referendum in the few days left and put it to another popular vote.

While I doubt if the EU would agree to keep the UK in the EU past the Brexit date of 29 March just for more pointless EU-UK negotiations, they might agree to delay it while the UK holds another referendum, or perhaps another election. In that case,  the “Remain” side might win this time and for Brexit to turn into Nexit – or would it be Bremain? Failing that though, I see no alternative to a “hard Brexit” – crashing out of the UK with no agreement at all. That’s the next-to-worst scenario for the pound. (The worst would be if Corbyn became PM and then they crashed out with no agreement.)

In any event, it’s likely to be an exciting week for the UK and for the pound!

As for the data, there’s not much on the schedule, and it’s questionable whether even that much will be released. US retail sales are expected to be up slightly and industrial production down slightly, but will the figures be released on schedule (Wednesday and Friday, respectively)? I’m not sure. In that case, the Empire State manufacturing index on Tuesday and the Philadelphia Fed index on Thursday will be the major US indicators. They’re both expected to be little changed, which will not be enough to distract investors from the government meltdown. The Fed’s Beige Book on Wednesday should also attract some attention.

Japan’s national CPI comes out on Friday morning Japan time, but that’s overshadowed by the Tokyo CPI nowadays. Besides, with the yen strengthening again, China’s economy slowing and trade tensions with the US heating up, there’s no hope of a change in Japanese monetary policy.

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Marshall Gittler

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