03 July 2019: Central Banks reasserting themselves

Central Banks reasserting themselves

July 3rd: Highlights

  • Fed cut now seemingly data dependent
  • Trade war and no-deal Brexit are risks, not certainties
  • Merkel abandons Weidmann to support Van der Leyen

FOMC members unsure on rate hike

The influence exerted by Central Banks over money markets had waned significantly over the period of recovery from the financial crisis as interest rates were slashed to zero and quantitative easing was introduced.

Once the stimulus was in place, the markets were left to recover as Central Banks took a back seat and concentrated on a more “administrative” role. The “patchy” nature of the recovery of developed nations and the advent of new crises means that as Central Banks try to influence their economies, traders’ acceptance of the premise that “Central Banks always win” is no longer unquestioned.

The questioning from several quarters of the need for the Federal Reserve to have hiked rates three times last year has been strengthened by the notion that one hike (at least) is about to be reversed.

Having changed their stance from one of “advance guidance” back to data dependency, the Fed appeared to almost bow to market sentiment by signalling an imminent rate cut at its next meeting.

Since then, Jerome Powell has testified to Congress that his preference for data dependency remains intact while several of his colleagues have questioned the need for an aggressive programme of cuts. Yesterday, Loretta Mester, the President of the Cleveland Fed., and a voting member of the FOMC carried on the latest theme when addressing a conference in London.

Her most telling comment was to say that “the Fed. won’t ignore signals, but the market is not always right”. This is in direct response to White House advisor Larry Kudrow’s comment recently that the markets were “demanding” a cut.

While successive FOMC members question the cut, the dollar is yet to recover fully from the FOMC’s statement. The release of the minutes of the June 18/19 meeting, set to be published on July 10th may provide more of a clue to individual members opinions.

Yesterday, the dollar index retreated a little following Friday’s rally, making a low of 96.61 and closing at 96.77. The imminent release of the June employment report is taking on greater significance as the market looks towards data dependency. Analysts are predicting a slightly lower figure for new jobs at around 160k with the average earnings increase set to remain around 3.1%.

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Carney felling a little redundant

Continuing the theme of Central Bank “relevance”, BoE Governor Mark Carney, who most graciously agreed to stay on past the end of his contract to aid with the effects of Brexit, evidently feels like a “third wheel”.

The Bank of England has been sidelined during the entire process and successive comments from the Governor have highlighted the risks of a no-deal Brexit, but until there is a concrete decision and policies are in place his role is to ensure inflation remains under control and growth maintained.

The latest data has shown that the UK economy is starting to show the effects of the combined threat of the global slowdown and Brexit but given the markets expected reaction, should a no-deal become probable, any stimulus will need to be fairly limited given the effect of a weaker pound on inflation.

Yesterday, Carney appeared to step away from the market’s expectation that the next move in UK interest rates would be a hike as he highlighted the risks to the economy as a smooth Brexit becomes less likely. Speaking at a Local Government Congress in Bournemouth, Carney hinted that the August inflation projections, which are currently being prepared, will predict lower inflation which increases the odds that the next move will be a cut.

Carney’s comments drove the pound lower versus the dollar with a low of 1.2584 being recorded and a close at 1.2594.

Versus the single currency, the “two-day rally” mentioned yesterday continued. Having closed higher for two days which has become a theme, the pound fell to a low of 1.1154, closing at 1.1160.

Politics drive the EU’s top jobs

Having seen her choice for the EU’s top job fall by the wayside as the three primary candidates for the position of President of the EU Commission were rejected, Angela Merkel succeeded in having her close ally, Ursula von der Leyen, receive the role.

It had been widely expected that Merkel would forsake that Germany’s time had come to have one of its nationals as the ECB President by wanting to have a German as President before she departs the Chancellorship.

The ECB Presidency is to be handed to a Frenchwoman in the shape of Christine Lagarde., the present Head of the International Monetary Fund. Madam Lagarde is a politician “by trade”, having headed the French Ministries of Agriculture and Commerce. She has also been Minister of Finance, Economy, and Industry, but that will be cold comfort to those Central Bankers who had their “eye of the role”.

A deal was evidently struck for President Macron to support von der Leyen in exchange for German support for Lagarde. In a similar way to Jerome Powell’s background as a lawyer, having a politician as President of the ECB may bring about a significant change in direction.

Having had a Dutchman, a Frenchman, and an Italian hold the top job at the Central Bank it is a major surprise that a German wasn’t given the job but evidently Frau Merkel sees the Presidency as far more important in driving the region forward as she considers her legacy.

As the Eurozone prepares for a change of economic direction, its current state remains uncertain. It is thought that the outlook is about to improve but data remains stubbornly underwhelming.

The fall in the euro over the past few months has had little effect on either trade or inflation and although the region has changed significantly over Sr. Draghi’s time in charge, he would have hoped to hand over the economy in a better state than Lagarde will find it.

Yesterday, the euro had a range of 1.1322 to 1.1287, closing, just a few pips higher on the day, at 1.1287.

Have a great day!

About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”