DUP says No

Chris Scicluna

After a disappointing retail sales report, US stocks failed to gain traction yesterday, with the S&P500 closing down 0.2%. And with little else to get the pulse going again – the lack of substantive news from the Brexit negotiations until a negative statement from the Northern Irish DUP in the past couple of hours (see below) being a case in point – the main indices in the Asia-Pacific region lacked impetus today, with Japan’s Topix closing down 0.45% and China’s CSI300 up just 0.1%.

In the bond markets, UST yields remained close to the bottom of yesterday’s range (10Y yields currently around 1.72%). But for a seventh day, yields on JGBs drifted higher, with 10Y yields up briefly coming within a whisker of -0.15% for the first time since early August before slipping back, the curve flattening, and the market-implied probability of a BoJ rate cut at the end of the month falling notably, even as a Nikkei news report suggested that the Government would tomorrow lower its assessment of the state of the economy in its regular monthly report to reflect the adverse impact of the consumption tax hike and the super-typhoon.

While there was a dearth of notable economic data from most of the region, a satisfactory Aussie labour market report (detail below) further took the pressure off the RBA to provide additional easing by year-end. So, yields on ACGBs were 4-5 bps higher across the curve. But the ASX200 was among the worst performers in the region (down 0.7%), as RBA Deputy Governor Debelle repeated concerns in a speech that much of the downturn in the Australia’s construction sector is still to come, with the Reserve Bank forecasting a further 7 per cent decline in dwelling investment over the next year with a non-negligible risk of a still-larger drop.

So, moving to Europe, it’s all about Brexit today. Overnight it had appeared that most of the key elements for a deal – perhaps with the exception of what to do about VAT – had fallen into place in the technical level negotiations. But there was seemingly still no legal text. And while there had seemed scope for a political agreement today, it was clear that domestic challenges, particularly for UK PM Johnson who has conceded most ground over the past week or so, remained. Those challenges were highlighted in the past couple of hours as the Northern Irish DUP, upon whose votes Johnson will rely to get any deal through the House of Commons, stated that it “could not support what is being suggested on customs and consent” while also noting that “there is a lack of clarity on VAT”. In response, euro area government bonds have on the whole made modest gains, but moves in Gilts have been predictably larger, with 10Y yields down about 3bps to below 0.68%. Sterling has lost about half a cent against the USD to close to $1.275, but the main European stock indices are little changed.

Of course, if it’s to come at all, DUP backing for a deal would seem bound to arrive at the very last minute, once it has extracted as many concessions as possible, not just with respect to Brexit arrangements but in a wide range of policy areas affecting Northern Ireland (indeed, last night it appeared that abortion rights were among the topics in focus). But unless the DUP comes on board for the proposed deal over the course of today or – at a stretch – tomorrow morning, the chances of a tangible outcome from the Summit and the prospect of some kind of meaningful vote in the UK Parliament on Saturday would be slim. Of course, EU leaders could pledge to continue to work on a deal and also pencil in a further Summit in the next week or two. But with plenty of work on the legal text of the Withdrawal Agreement still required in the event of a political agreement, as well as implementing legislation in the UK and EU also needed in due course to implement any kind of Brexit deal, an extension of the Article 50 deadline beyond the end of the month still seems inevitable.

As it stands, under the draft Brexit proposals, a regulatory and customs border would be established down the Irish Sea for administrative purposes and Northern Ireland would have to follow EU rules on tariffs and quotas – the kind of arrangements that it previously had seemed impossible to imagine the DUP (or, Theresa May suggested, a Conservative UK Prime Minister) giving its backing too. However, to fudge matters, Northern Ireland would also legally remain in the UK’s customs territory. And so, arrangements would be established to provide Northern Irish firms with rebates on EU tariffs in certain circumstances and there would also be exceptions for people moving personal goods between Great Britain and Northern Ireland. In terms of the consent issue, meanwhile, the Stormont Northern Irish Assembly would be asked to agree to maintain the arrangements four years after the end of the transition period, and on a rolling basis thereafter. Nevertheless, unlike Theresa May’s backstop, the proposals imply scope for Northern Ireland to have different customs and regulatory (and probably VAT) arrangements from the rest of the UK on a permanent basis. So, all up, it’s no great surprise that the DUP is holding out for further concessions.

While investors will obviously respond first and foremost to the newsflow on the Brexit negotiations and any further related information that emerges from the DUP or the EU Summit, today will also bring September’s UK retail sales data. Surveys point to a second successive weak month for sales with a modest decline in the headline monthly rate likely. That, however, would still leave sales up over the third quarter as a whole. Separately, BoE Governor Carney will speak publicly in Washington DC.

The latest Aussie labour market data were probably as good as might have been hoped for an RBA that will want to hold off for as long as possible from cutting rates further. Among other things, broadly as expected, employment rose by 14.7k in September leaving the rate of increase on a year earlier at 2.5%Y/Y. The increase in people in work this month was more than fully explained by full-time jobs (up 26.2k) and – once again – women (up 21.4k) while the employment gain in the prior month was revised up slightly too. With the participation rate inching down 0.1ppt from August’s series high to 66.1%, the unemployment rate fell 0.1ppt too, to 5.2%, matching the average rate so far this year. Underutilisation and underemployment rates also dropped in September, by 0.2-0.3ppt to 13.5% and 8.3% respectively, adding to evidence of a slight tightening of labour market conditions last month. Nevertheless, the unemployment rate remains some way above the RBA’s estimate of the NAIRU (close to 4½%), and a renewed uptrend in participation might still be expected over coming quarters. So, we won’t be holding our breath for the meaningful acceleration in wages (from just 2.4%Y/Y in the private sector in Q2) required if the RBA is going to steer inflation back to target on a sustained basis.

Euro area:
Today should be relatively uneventful for economic news from the euro area with August construction output data the sole new release of note. Not least given the 1½%M/M drop in Germany, these are likely to show a fifth decline in production in the sector in six months. In addition, the Presidents of the National Banks of France (Villeroy), Italy (Visco), Spain (De Cos) and the Netherlands (Knot) will speak publicly in Washington DC. In the markets, France and Spain will sell a range of bonds.

In the US, the data-flow will bring industrial production, housing starts and building permits data for September, as well as the October Philly Fed survey results and usual weekly jobless claims numbers. FOCM members Williams, Bowman and Evans will speak publicly. In addition, the Treasury will sell 5Y TIPS.

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