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  • Brexit back to square-one with increased risks for hard Brexit
  • US/Chinese tensions continue as Huawei’s Meng still seeks bail
  • U.S. PPI expected to ease 
  • 3-year T-note auction to yield near 2.73%
 

Brexit back to square-one with increased risks for hard Brexit — Prime Minister May on Monday crashed and burned with her Brexit withdrawal plan.  She announced that she was postponing Tuesday’s scheduled Parliament vote since the plan was clearly going to be voted down by a wide margin.

Sterling yesterday fell sharply by -1.30% to a new 1-3/4 year low on the news due to the increased chance that Brexit will crash out of the EU in March 2019 with the ensuing chaos of a hard customs border.  The UK FTSE index yesterday closed the day -0.83% but managed to stay above last Thursday’s 2-1/4 year low, where the index corrected lower by a total of -15.6% from May’s record high.

Ms. May said she would now go back to the EU and do “everything I possibly can” to secure assurances that the UK will not end up stuck forever in the Irish backstop.  However, the EU said that the binding language of the agreement will not be negotiated and that the most Ms. May could hope for would be a reassurance that the EU would not want to keep the UK locked in the Irish backstop forever where the UK would remain within the EU but without representation.

Ms. May would not give a date for when she might return to Parliament for a vote on a Brexit withdrawal deal.  The deadline is January 21 since that is the date that the government must report to Parliament on its plan if there is no deal.  Since Ms. May will need time to confer with EU leaders, a Parliament vote doesn’t seem likely until January.

The markets will now be watching UK political developments to see if Ms. May faces a leadership challenge from within her party or if she faces a no-confidence motion that results in new elections.  Ms. May seems to have little chance of having her plan approved by Parliament even if there are minor EU adjustments to the plan.

Yet, there appears to be no other Brexit separation plan that the EU will approve that satisfies the requirement of no hard border for Northern Ireland.  If Parliament will not approve the current plan, that might mean that the only options are for the UK to stay in the EU (via a second referendum) or for a hard Brexit with WTO tariff terms with the EU.

US/Chinese tensions continue as Huawei’s Meng still seeks bail — The markets continue to wait to see if China will retaliate for Canada’s arrest of Huawei CFO Meng at the behest of the U.S. for alleged Iran sanctions violations.  Ms. Meng’s bail hearing continued on Monday without resolution.  Ms. Meng is seeking to post bond to be able to live in Vancouver while the U.S. extradition process plays out.  The judge in the bail hearing, however, seemed skeptical about providing bail since Ms. Meng has substantial financial resources and might seek to escape the country.

Ms. Meng’s arrest was a huge provocation for Chinese President Xi, who might have no choice but to retaliate in some manner.  The markets fears that Ms. Meng’s arrest could accelerate the “tech war” between the U.S. and China where the two countries seek to hamstring each other’s tech companies.

U.S. PPI expected to ease — The market consensus is for today’s Nov final-demand PPI to ease to +2.5% y/y from Oct’s +2.9% and for the core PPI to ease to +2.5% y/y from Nov’s +2.6%.  The headline PPI is expected to ease largely due to the plunge in oil prices in October and November.

The market’s worries about inflation have eased substantially in the past two months.  The 10-year breakeven inflation expectations rate yesterday fell to a new 1-year low of 1.86%.  The rate has now plunged by -35 bp from May’s 4-1/4 year high of 2.21%.  That sharp drop gives the Fed some room to pause its rate-hike regime in 2019 since inflation is currently on its way lower.

In fact, the PCE deflator, the Fed’s preferred inflation measure, has moderated in recent months, signaling that the actual inflation figures are moving lower as well as inflation expectations.  The core PCE deflator in October fell to an 8-month low of +1.8% from the 6-year high of +2.0% posted earlier this year in May-July.  The headline PCE deflator fell to an 8-month low of 2.0% in Sep-Oct from the 6-year high of +2.3% posted earlier this year in May-July.  The recent weakness in the deflator is particularly seen by the fact that the core PCE deflator in October fell to a 1-1/2 year low of +1.1% on a 3-month annualized basis.

 

 

 

3-year T-note auction to yield near 2.73% — The Treasury today will sell $38 billion of 3-year T-notes.  The Treasury will then continue this week’s coupon package by selling reopened $24 billion of 10-year T-notes on Wednesday and $16 billion of 30-year T-bonds on Thursday.  

Today’s $38 billion 3-year T-note issue was trading at 2.73% in when-issued trading late yesterday afternoon.  The benchmark 3-year T-note yield yesterday fell to a 3-1/4 month low of 2.69% before rebounding higher to close the day at 2.72%.  The 3-year T-note yield has fallen sharply by an overall -36 bp from early-Nov’s 11-year high of 3.05% to yesterday’s 3-1/4 month low of 2.69%.

The 12-auction averages for the 3-year are as follows: 2.80 bid cover ratio, $83 million in non-competitive bids, 3.4 bp tail to the median yield, 20.1 bp tail to the low yield, and 53% taken at the high yield.  The 3-year is the second least popular security among foreign investors and central banks behind the 2-year.  Indirect bidders, a proxy for foreign buyers, have taken an average of only 48.6% of the last twelve 3-year T-note auctions, which is well below the average of 63.2% for all recent coupon auctions.

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