12 June 2019: Fed. preparing for a rate cut

Fed. preparing for a rate cut

June 12th: Highlights

  • President Trump accuses Eurozone of “deliberate devaluation”
  • “One issue” leadership battle hotting up
  • Draghi’s “most dovish speech yet” to undermine euro?

Trump takes aim at EU after Mexico triumph

President Trump, fresh from reaching an agreement with Mexico over trade and migration, has tweeted that he believes that the EU is deliberately devaluing the single currency to provide it with an unfair advantage in global trade.

Without producing any evidence of the EU’s actions, the facts contradict this assertion. There is little doubt that the economy is struggling and rates are at historic lows although the ECB has withdrawn its Asset Purchase Plan.

President Trump is clearly flush with the success of his new diplomatic ploy where he threatens a nation’s economy in order to get what he wants in another area. This may work with a more dependent country like Mexico, but China will see things differently.

Next week, the FOMC gathers for what could be Jerome Powell’s most important meeting yet.

Given the slowing economy, as evidenced by recent data, Powell is expected to deliver a dovish assessment of the options facing the Central Bank in the coming months. The acceptance of the premise that the current slowdown is more than a speed bump in the road could send the dollar down to test its lows for the year.

Expectations are growing that the Fed will cut rates within the next few months in order to provide a measure of stimulation. Powell will need to manage the cut in order to ensure that it doesn’t appear to the market that it is an admission that the “wait and see” policy failed, and they should have acted sooner.

A rate cut would probably achieve President Trump’s twin economic goals of a stronger stock market and a weaker dollar although he will certainly take credit when it happens.

The release of inflation data later today should also provide the Fed with more ammunition to cut rates. Headline inflation is expected to have fallen to 2% or possibly lower in May.

Yesterday, the dollar index resumed its correction, reaching a low of 96.64 and closing at 96.72.

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Employment data surprises to the upside

The release of employment data by the UK yesterday was supposed to be a more tangible signal that the economy is slowing down. In fact, the opposite was true as the report was more favourable than expected.

Two issues are causing analysts to become more than a little sceptical about the data and see it turning around in the coming months.

First, with employment at its highest level for 40+ years why aren’t tax receipts also approaching record levels? Second, if manufacturing and industrial production are falling as seen on Monday, how are more jobs being created?

The economy has been largely ignored during the “May years” with Brexit the only game in town.

This sentiment also provides the theme for the next Prime Minister too, as having avoided a “one issue General Election”, the Conservative Party stages a “one issue” Leadership Contest.

Today sees the favourite to win the contest Boris Johnson launch his campaign, as well as Home Secretary Sajid Javid. Javid is seen as something of a dark horse in the contest. His record as Home Secretary has been chequered with a success over the Windrush scandal being balanced by feeling that he has been too soft on knife crime.

Tomorrow’s first ballot, which will test the Party’s new tougher rules, may see the field cut in half. In order to advance to the next round, a candidate must receive around 5% of the vote. There will be tactical voting, but several hopefuls could see their campaigns come to a sudden end.

The pound remains in the thrall of the possibility of a hard, no deal Brexit. Five current candidates would accept no deal in order to leave by 31st October while four see it as still on the table. The lone exception, Rory Stewart, believes that the UK should not, under any circumstances, leave the EU without a deal. Stewart, who launched his campaign yesterday, is considered a lightning rod for those Government MPs who favour a soft Brexit.

Yesterday, Sterling rallied versus both a weaker dollar and a struggling euro, closing at 1.2723 having reached 1.2733 and 1.1234 with a high of 1.1247 respectively.

Draghi ready to accept the need to act

ECB President Mario Draghi will make a speech today in which he is widely expected to acknowledge the difficulties facing the Eurozone and the need for the Central Bank to act. It must be galling for Sr Draghi since he has been left with a policy cupboard which is bare and possibly falling apart.

Central Banks had clearly become used to cutting rates to zero and expect both growth and inflation to start to increase giving them the relatively simple task of applying a liberal amount of braking to avoid overheating.

That economic playbook has been torn up, mostly due to the unexpected issues facing global trade. In the past, the U.S. could pretty much dictate the terms on which it traded with its partners. This kept a degree of equilibrium and weaker currencies were something of a trade-off.

The reintroduction of quantitative easing by the ECB is a real possibility and with hindsight, last year’s clamour for it to be rescinded which started in January, was maybe a little over-confident about just how robust the economy was.

It would have been hard to predict the effect the U.S./China trade talks would have on both risk appetite and the Eurozone economy, but it has illustrated perfectly just how the Central Bank operates in something of a vacuum due to the lack of a regionwide fiscal policy.

The euro remains in a downward spiral despite several calls made by analysts that it is close to the bottom. The value of the single currency is driven by the dollar right now and while the jury is still out on the greenback, it remains out for the euro.

Yesterday, it reached a high of 1.1338 versus the dollar, closing at 1.1327. 1.1320 is supposed to be a resistance level and a sustained break could open 1.1480 but given the influences upon the currency that may take some time to achieve.

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.”