There are tentative signs that the euro might stabilise above 1.17 level after the 80 point sell off post-election result, which suggests that 40% of Catalans, over 2 million people, voted for independence, which is about 90% of the total number who were able to vote after the clashes and polling station closures during the weekend.
Although this is a major political event that could change the course of Spanish history, it is yet to become a financial market event, and the Spanish bond yield only rose 10 basis points this morning, suggesting that bond investors are not worried about the vote for now. This does not mean that the quest for Catalonian independence and the breaking up of the fourth largest economy in the currency bloc will be ignored by markets indefinitely.
Catalan vote no threat to the EU, yet…
The outcome of this event is still very uncertain as the vote has been declared illegal, which has caused mild confusion in financial markets rather than panic. Right now the market is taking a breather after the German vote, which has seen Angela Merkel reinstated as the de-facto leader of the EU, and the populist threat from France and Holland has been quashed, which continues to lend support to European equities, which are mostly higher today. Interestingly, the equity market suggests that the Catalonian vote is being treated as a domestic event since the Catalan movement doesn’t want to destroy the EU or end Spain’s membership of the euro, thus it is only having a localised effect on Spanish markets: the IBEX is down some 1.15% so far today, its largest daily drop since mid-August.
Dearth of trends could support euro for now
If Spanish events can’t bring down the euro in a meaningful way, then future euro weakness may depend on dollar strength. While we think that EUR/USD could fall back to the 1.1570 mark, the 100-day sma, the real momentum to the downside may not come until the market pushes EUR/USD down to 1.1430 – the 38.2% of the recent uptrend, which is some 300 pips away. Although the dollar has attempted to rally, it has been fairly tepid so far. The market at least needs to break 94.20 – mid-August highs – before a change in trend can be considered a reality. We believe that the dollar will rally, but we struggle to get excited about a change in trend while it appears to take one step forward and one step back.
A slow cooldown for the UK economy
The pound is also in focus this week, today’s manufacturing sector PMI for the UK highlights the slight cooling in the economy at the end of Q3, with the index slipping to 55.9, down from 56.7 in August. We expect the rest of the surveys to also show signs of moderation as the UK economy enters a period of slow cooling rather than falling off a cliff.
Demand for pound strong even as it backs away from highs
The pound has also fallen away from its highs, even though speculative demand for sterling has been growing, with the first net long reading for 2 years. When sentiment shifts this sharply it can be considered a contrarian sign and lead to some currency weakness, which could be happening this time. We believe that a further decline back towards 1.3020 – the 38.2% retracement of the Jan low to Sept high, could be met with buying interest as there is demand for sterling out there, as the CFTC data shows.
Will Theresa May remain toxic for the pound
However, it is worth noting that this week’s Tory party conference could hasten the pound’s demise. Last year’s speech by Prime Minister Theresa May, where she touted a hard Brexit, caused GBP/USD to dive some 6%. We expect the reaction to be milder this time, as the market has become used to Tory party in-fighting and as Theresa May tones down the hard Brexit rhetoric to try and break the impasse on the Brexit negotiations and to appeal to the 48% of Brits who voted to remain in the EU. However, it is worth remembering that Theresa May can be toxic for the pound, and its fall was accelerated after her Florence speech last month. That and the fact that September PMI’s between the UK and Europe highlight the UK’s economic vulnerability, suggest it could be a tough start to the month for the pound.
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