No panic in the UK yet but a definite moderation

If the PMI data was a gauge of economic sentiment post the triggering of Article 50 alone, then one could argue that the early stages of our exit from the EU has caused a definite moderation in growth, but so far no panic. Of course, this is early days, and the PMI surveys are impacted by multiple factors, but the decline in the manufacturing and construction PMIs, two sectors impacted by Brexit, suggests that the economic impact of the decision to leave the EU may start to show itself more than nine months after the vote to leave the EU.

The key test will be the services sector PMI due out on Wednesday, if it’s a hat trick of weaker than expected data, we would expect this to be reflected in weaker sterling and UK equities. GBP/USD had a bad start to the quarter, but it has found some support at the 50-day sma at 1.2430 this morning, this is helping to boost sterling for now, but we could see it falling below this level if the economic data starts to slow.

UK economic data misses start to add up…

The slowdown in UK economic data is now notable, and the Citi economic surprise index for the UK is at its lowest level since the start of the year. This has caused a moderation in UK gilt yields, and the 10-year Gilt yield is at its lowest level since October, after falling through the 200-day sma. The spate of disappointing economic data has also impacted UK interest rate expectations, the OIS market has reduced expectations of a rate hike by the end of this year, last week the prospect of one hike was at 32%, today the probability is 22%. With Kirsten Forbes, the BOE’s only hawk who voted for a rate rise last month, leaving the BOE later this year, it is hard to see how anyone else will vote for a rate hike in the coming months due to the spate of weaker than expected data. It is hard to see how sterling can rally in a meaningful way in this environment; the 10-year UK-US bond spread has also turned lower again and is currently at -127 basis points.

Risk sentiment takes a knock

Moderation in the economic data isn’t unique to the UK; there has also been disappointment in the Eurozone and the US, although it hasn’t been as acute as in the UK. However, it has been enough to weigh on global risk sentiment. US stocks started the second quarter of this year on the back foot after a mix of weaker car sales in the US and an explosion in St Petersburg dented sentiment. We have mentioned the importance of lead indicators for the US stock market, the Dow Jones transport Index is more than 5% lower in the past month, after recovering slightly last week, it turned lower again on Monday, we will be watching this index closely to see if Monday’s price action was a blip and it continues its recovery today, or if it falls further on Tuesday, which would bode ill for the broader US indices at the start of Q2.

Jacob Zuma’s legacy: South Africa loses its sovereign rating

Elsewhere, the rand has extended its decline vs. the USD on Tuesday after the S&P ratings agency cut the country’s sovereign rating to junk status on the back of Jacob Zuma’s decision to sack his widely respected finance minister last week. This is the first time that South Africa has not had investment grade status in 17 years. Volatility in the rand is surging, and it is, unsurprisingly, the most volatile currency in the EM FX space, with USDZAR implied volatility now at 17%.

French election debate, can Le Pen boost her chances?

The French election is also in focus on Tuesday as we wait for the second Presidential debate tonight. As we lead up to the debate, we have seen expectations of Macron to win the second round vote slip to 63%, while Marine Le Pen’s odds of winning have risen slightly to 25%. Watch the performance of Socialist Party candidate Melenchon during tonight’s debate. His support has risen strongly with only three weeks’ to go. While we don’t expect him to win and progress to the second round, if he performs well tonight then it is worth watching who he is more closely aligned with – Macron or Le Pen – as his endorsement could throw this Presidential election.

As we lead up to the election later this month, the euro has been retreating and EURUSD has fallen below its 50-day sma at 1.0670. The French-German 10-year yield spread has also been on the rise again as we lead up to tonight’s debate, it currently stands at 66 basis points. If Le Pen wins tonight then we would expect a swift decline in the euro and a sharp rise in the French-German yield spread.