Divergence Reinvigorated

Last week the focus was on Europe. Prospects of a delay in Brexit helped extend sterling's gains to 11-week highs.Disappointing flash PMI for the eurozone and a dovish Draghi pushed the euro below $1.13 for the first time since mid-December.  

Speculation that the Reserve Bank of Australia would be forced to cut interest rates saw the Australian dollar punch through $0.7100. For its part, the yen was sidelined. The dollar stalled at JPY110 and has remained above JPY109.30 for the past three sessions. The focus in the days ahead may turn back to the US, where the highlights include the FOMC meeting and the January employment report.  

Still, Europe requires attention. The German manufacturing PMI falling below the 50 boom/bust level for the first time in four years and the ECB offering a change in its risk assessment for the first time without staff forecast update underscores the seriousness of the economic challenges of the euro area. Some of the political fallout may be seen in the European Parliament elections in May, which often favor the smaller and more passionate parties. 

Draghi speaks to the European Parliament and investors will look for any elaboration for his press conference after the ECB meeting. Although Draghi argued that ECB has numerous tools at its disposal, it appears a consensus is forming around a new Targeted Long-Term Refinancing Operation (TLTRO) and possibly in its forward guidance pushing out the first hike into 2020. 

Investors will get the first look at Q4 18 EMU GDP.Economists mostly expect it to match the 0.2% of Q3 after 0.4% in the first two quarters and 0.7% each quarter in 2017. The risk is on the downside. Although the Bundesbank says German narrowly escaped a second consecutive quarterly contraction, Italy may not be as fortunate. The economy is expected to have contracted by 0.1% as it did in Q3. The ECB's survey of professional forecasters reported before the weekend saw 2019 GDP forecasts cut to 1.5% from 1.8%. They put 2020 GDP also at 1.5%, which seems match trend growth and if it is somewhat optimistic, so are officials. The IMF's new forecasts are for 1.6% and 1.7% growth this year and next respectively.  

The next act of the Brexit drama has begun. May's Plan B to limit the backstop may draw more support by her own allies under the threat of a possible second referendum that might see the Brexit ditched all together or an election in which the opposition could win. However, by its nature, the backstop cannot be so limited. It defeats the purpose, which is to prevent a hard border between Northern Ireland and the Irish Republic. And EC negotiators and Ireland have made this point many times. 

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Read more by Marc on his site Marc to Market.

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