1. Brexit: The stalemate continues.
At an unusual Saturday sitting, the UK's Parliament didn't vote on the recently negotiated Brexit deal after a majority of 322 against 306 instead pushed through an amendment that effectively postponed the final decision on Johnson's deal. Following the large moves in sterling over the last week, we will likely see further volatility in the days ahead as the next phase of Brexit unfolds. Three scenarios remain possible, in our view. The first is a general election, followed by a deal. Here we expect the EU to accept the requested extension, although their decision may not be immediate. Johnson will press ahead with efforts to pass Brexit legislation to ensure a 31 October departure. Whether he succeeds or fails, we expect to see a general election before the end of the year. As investors assess those prospects, we expect GBPUSD to settle in a 1.26 to 1.32 range. The second scenario is this deal eventually passing. Here we would expect GBPUSD to rally to 1.35. Beyond those levels, we think, sterling would struggle to rise as concerns about the long-term trade relationship will come into focus. And the final scenario would be a no-deal Brexit. The risks of a no-deal at the end of October, or in the next six months, are lower than they have been for many months. The no-deal outcome would have hurt GBPUSD, pulling it down toward 1.12, in our view.
Takeaway: We maintain our preference for sterling over the US dollar.
2. Earnings: Slowing, but not plummeting.
The US 3Q earnings season kicked off recently, with 20% of the S&P 500 by market cap having reported results. Consensus estimates suggest earnings will contract by 4% y/y. While earnings growth has undoubtedly slowed given the softer macro environment, we think that consensus may be overly pessimistic. Our estimate is for a 2% contraction for the quarter. Though this would be the first quarterly drop in profits since 2016, 3Q will likely mark the low point for quarterly year-on-year earnings growth. Flattish earnings at the index level also mask more resilient profitability for the "typical" US company. Weakness is concentrated in the energy, materials, and technology sectors, as well as in select mega-cap stocks. However, the median S&P 500 company should grow earnings 4%–5%. Further, the consumer staples and consumer discretionary sectors remain well supported by healthy consumer fundamentals (a strong labor market and healthy wage growth), and should continue to enjoy solid organic growth.
Takeaway: 3Q results are likely to be a mixed bag for markets, though investor hopes for a trade deal between the US and China should limit the downside. We like the US consumer discretionary, communication services, and consumer staples sectors.
3. Soft data leaves room for the Fed to act.
Last week, US retail sales unexpectedly slipped for the first time in seven months, sparking concern that the US consumer is starting to feel the effects of a potential slowdown. While we don’t advocate reading too much into one data point, this development does reinforce our view that the Federal Reserve will cut rates on 30 October, given the potential risks to the economy. Manufacturing sentiment remains weak, with the US ISM print at 47.8 for September, and last week’s Federal Reserve Beige Book pointed to a worsening outlook. Global growth looks set to drop to roughly 3% next year, the slowest pace since 2009. And trade tensions still have not been resolved, which means capital expenditure is unlikely to rebound sharply. While central bank action should curb the downside for stocks, the upside looks limited until greater clarity over trade emerges. We maintain a preference for carry strategies in this environment.
Takeaway: We overweight US-dollar denominated emerging market sovereign bonds, select high-yielding EM currencies, and US Treasury Inflation-Protected Securities (TIPS).
Can the pound hold on to its gains?
After a failed attempt at pushing the Brexit deal through parliament, GBPUSD briefly dropped on 21 October by as much as 0.6% to trade below 1.29, ending its four-day rally. With another vote on the cards this week, we expect sterling volatility to continue, though the downside risks have diminished in recent weeks due to a no-deal scenario becoming increasingly unlikely.
Will sentiment pick up?
Recent hard data prints have shown signs of a slowdown in the US, with both retail sales and factory output slipping. Meanwhile, 3Q GDP in China also dropped to an annualized 6.0%, a 27- year low. This week we will see PMI data from Japan, the Eurozone, and the US, and investors would likely welcome a positive surprise amid recent weakness. We maintain our underweight to equities.
Will the interim trade deal hold?
Last week we received conflicting signals on what China and the US had agreed to as part of their 11 October announcement. China reportedly wanted USD 50bn worth of existing tariffs and the proposed December tariff increase taken off the table before reaching a deal, while US Commerce Secretary Wilbur Ross said those tariffs are the only reason they are at the negotiating table. We will be looking for further details about what makes it into the final deal.