Sterling has overshot to the downside

Outlook:

Institutional Events like the May comments on Brexit always have the power to trump economic data. But some data can't be overridden and the foremost example is US pay-rolls. The next release is Friday morning. Don't kid yourself it won't make a big difference in how all other data is viewed.

So far this year, the monthly average is 182,000 net new jobs per month, less than the 2015 monthly av-erage at 229,000 but still a decent number and with skilled labor shortages in some places, offering some upward pressure on wages. This time the forecast is for 170,000, less than the 2016 monthly average. The small drop vs. the average doesn't pass the "So What?" test, and economists everywhere warn we must expect deceleration as full employment is upon us, but just wait—a number too far under the medi-an forecast will be seen as subpar and the beginning of The End.

A low number like 120,000-130,000 would set off hysteria over the Fed needing to stay its hand in De-cember. Meeting the consensus number should be neutral and exceeding the number would also be neu-tral, unless it's a huge overshoot, in which case it would be yield and dollar-friendly. And remember that the dollar nearly always rises on the Wednesday going into payrolls for reasons we have never discov-ered. Short-covering, maybe.

The other big development in global economics is to what extent Brexit is going to damage the UK economy. Chances are good that passporting will take a hit along with inward investment, employment in various sectors in addition to finance, and consumer morale. In a general acknowledgement of unhap-py events to come, today Ireland cut it growth forecast for this year to 4.2% from 4.9% and to 3.5% from 3.9% next year. These are substantial reductions and imply the Irish finance ministry economists are seriously frightened.

We now await similar cuts in forecasts from other EU members. Granted, Ireland is closer to the UK in most ways but now the dam has burst, we should expect lowered expectations everywhere else, too. As noted over the summer, some Continental economists see as big a negative effect on European econo-mies as on the UK economy.

The UK government is pursuing two objectives of the Brexit referendum—sovereign control over immi-gration and refugees, and the supremacy of UK law over European law. The European system is a lot like US state courts being constitutionally required to observe federal law over state law. Some state courts don't like the Supreme Court ruling that they must allow same-sax marriage, for example. It's a clash of sovereignties in which the federal law overrides the state law. In the UK case, the referendum rejected EU sovereignty over UK law, as though the UK was Alabama. Refusing to abide by European court decisions is probably a bigger deal than we now suspect. Political science courses on sovereignty will be debating this one for years to come.

Europeans are deeply offended. One set of common European laws pertains to commerce and so some Europeans automatically rush to the trade-off of sovereignty in law with free market access. One Brus-sels diplomat told the FT "The single market entails giving up legislative autonomy. I can only conclude she is ruling out participating in the single market."

Well, no. Saying you want control over your own laws doesn't necessarily have anything to do with the single market. For example, the UK could agree up front to accept all the EU's laws on commerce (competition, etc.). This seems to be a non-starter, though. The FT says that those arguing about it draw a distinction between "access" to Europe's single market and "participation" in it.

Norway and Switzerland have access without participation. One way they do this is by demonstrating that their commercial law is the "equivalent" of EU law. We say it's hilarious that the Europeans, who historically have tinkered with free markets to make them less free, are setting themselves up to judge the free market credentials of the home of the free market concept. And the Brits are not unware of this. The FT notes "Downing Street is confident that the deep economic ties and common regulatory starting point will encourage the EU to establish a more ambitious model, which might be somewhere between a trade deal and full single-market membership."

The FT also writes that one idea floating around, but one that will not probably float to the top, is sector-by-sector negotiation, aka cherry-picking. The problem is that if the UK gets special deals for autos, pharma or finance, other EU countries may start to get ideas. Hungarian goose-down pillows, maybe. Bloomberg shames itself with yet another fiery headline to the effect that May is dumping the City by declining to prioritize the financial sector and declining to review the plans put forward by the banks themselves. "Officials say the City risks damaging relations even further by repeatedly threatening to move jobs abroad, as the likes of JPMorgan and UBS have done.

"May's approach is despite the fact that financial services contribute almost 12 percent of economic output, 1.1 million jobs and £65 billion ($83 billion, €75 billion) a year in tax revenues. The insight into her thinking comes just as the industry prepares to release another report outlining the downsides to the U.K. from a shrunken financial sector.

"But officials believe the ultimate impact of Brexit on the City will simply be smaller bankers' bonus-es, with just a few hundred jobs moving elsewhere in Europe. And they argue voters will welcome the new attitude after the financial crisis."

Oh, so not on fire, after all? It seems not to occur to the Bloomberg reporters (or the inside sources) that pretending to treat the financial sector no differently than any other sector is precisely the point. Make a big deal about the City and you hand the EU a weapon.

We are impressed by May's no-nonsense, resolute manner. She is like the common-sense schoolmarm who listens (for a limited period of time) to feuding 8-year olds and then makes a decisive ruling from which there is no appeal. Style counts. It can't offset all data, all the time, but we expect to see sterling respond favorably from time to time on the strength of good governance alone. The confidence fac-tor should not be underestimated. In fact, sterling has overshot to the downside. Considering the linear regression channel from the day after Brexit, the overshoot is visible. A classic bounceback could take the pound to the linear regression itself, which lies at 1.3092 tomorrow. The point: don't get too gung-ho shorting sterling.

Political Tidbit: Trump excuses paying no taxes on the grounds that it was smart and responsi-ble. The legal nitpickers point out that an imaginary fiduciary responsibility to oneself does not exist in the law and is only an excuse for personal greed. Trump is using a false argument.

Besides, a new study coming out today, reported in the NYT, finds that most big international corpora-tions are far savvier and clever in exploiting loopholes than Trump. Of the Fortune 500, 73% had off-shore tax haven subsidiaries in 2015. "If all the Fortune 500 companies paid taxes on their sheltered profits, the researchers tallied, the government would receive a whopping $717.8 billion windfall. To put that number in context, the 2015 federal budget deficit was $438 billion.

"The researchers reported that Apple holds $214.9 billion offshore and would owe $65.4 billion in tax-es if that money came back to the United States; Nike holds $10.7 billion offshore and would owe $3.6 billion in United States taxes; Goldman Sachs holds $28.6 billion offshore, and the report says the com-pany ‘reports having 987 subsidiaries in offshore tax havens, 537 of which are in the Cayman Islands despite not operating a single legitimate office in that country, according to its own website.'"

Yes, indeed, the US needs corporate tax reform. None of Trump's proposals include fixing the loop-holes he exploits, though. Analysts say the ill-informed Trump voters buy the "tax avoidance is smart" story and so the scandal will not affect the election. But using tax loopholes to avoid responsibility for a billion dollar failure makes Trump an insider, not the outsider that is his claim to fame. We say it could be as decisive as Romney's "47%" if the Dems play their cards right.

Nobody much is commenting on the losses taken by banks in all this. Trump may have borrowed near-ly all of the $916 million he lost. That's why the big New York banks do not lend to him anymore (yes, we have stories) and his bankers are in places like China. The US embarrasses itself with this guy.