At the Dollar’s mercy

​Today's news headlines:

  • ‘Boris Johnson wins Tory contest to become UK Prime Minister'. Boris Johnson beat Jeremy Hunt to become Theresa May's successor, securing 92,153 votes vs Hunt's 46,656. Resignations from Ministers are expected over the coming days and investors will be watching who Johnson appoints in his Cabinet. A developing Cabinet of hard Brexiteers and Johnson's 'do or die' approach increases the chance of a no-deal Brexit. (Financial Times)
  • ‘US negotiators to head to China Monday for face-to-face talks'. US trade representative Lighthizer and other senior officials will travel to China next Monday for the first round of high-level negotiations since talks broke down in May. The meeting is a positive step for the ongoing trade war, but the two nations are expected to address what the current situation is rather than achieve substantial negotiations. (Bloomberg)

Back to the table

US trade officials are set to head back to China next Monday for face-to-face trade talks with their Chinese counterparts. A broad range of issues will be on the agenda in the first high-level negotiations between the world’s two biggest economies since talks broke down in May. Following the G-20 meeting between Trump and Xi, a gentleman’s agreement prevailed which would result in substantial Chinese purchases of US agriculture products in return for the removal of Huawei sanctions. That hasn’t quite gone as planned, so we expect these topics to resurface, along with more prominent issues like Chinese structural reform and the protection of US intellectual property. Stocks reacted positively to the prospect of a meeting, as the S&P 500 closed almost 0.7% higher, but officials have played down the likelihood of a quick deal. In an interview with Bloomberg yesterday, Secretary of Commerce, Wilbur Ross, reiterated the importance of getting the right deal for the US, while being prepared to enforce new tariffs if talks are unsuccessful.

Bottom line: There was almost a deal back in May when US negotiators claimed there was 10% left to be negotiated, but it’s unlikely that talks will resume anywhere near that stage. There is some evidence that the Chinese electorate has turned against a convenient deal with the US, which means both sides need to be able to demonstrate a big win in order to sell an agreement domestically. Concrete evidence of progress will buoy risk sentiment in markets and could lead to an appreciation in the Dollar.

Clouds gathering

It's difficult to make a compelling case that Europe is doing well in an economic sense. If we really try, we can tell ourselves a story about eastern European nations and the great boom they are experiencing, but the story comes to an abrupt halt. The Services Purchasing Managers Index (PMI)— a survey of business conditions—was still indicating expansion at the start of the month, but the important ZEW Economic Sentiment Survey has been in negative territory since mid-last year. Perhaps worry stems from deteriorating manufacturing across the bloc. Today, a slew of fresh PMI data is being released; Germany and France, the two largest economies in the EU, have already disappointed on both service and manufacturing readings. 

Tomorrow's European Central Bank (ECB) presser is rather appropriately expected to announce a new bout of monetary policy easing, but it's not clear how that can really help. The ECB's deposit rate has been in negative territory for five years, and if policymakers want to extend QE, they may soon need to start purchasing stock indices like the Bank of Japan. But very much like the raft of negative-yielding European government debt—which completely under-prices redenomination risk in our view—the European Stoxx 600 is fast-approaching decade and pre-crisis highs. A large-scale purchase of those assets would very likely lead to worse asset bubbles. Europe and Germany, in particular, need to ramp up investment if they wish for the economic situation to improve, the ECB can't shoulder the burden for much longer.

Bottom line: The fundamental economic view would strongly argue for a weak EUR, particularly as the ECB eases policy. However, the EUR is really at the mercy of the Dollar, which has been accumulating strength as the global growth picture has darkened.  The coordinated central bank easing that is underway could arguably improve the backdrop enough to increase the pace of global growth and lead to Dollar weakening/Euro strengthening. That's the last thing the EU would need.

GBP/USD

The trade-weighted Sterling Index was largely unchanged following Boris Johnson's Tory leadership victory and remains close to all-time lows. The pair remains 3.5% below its 200-daily moving average and can sustain its recent decline as the Dollar climbs due to anticipated fiscal stimulus.

GBP/EUR

Following Johnson's victory, the pair has maintained its recent rebound from its 10-week slide. British politics will continue to be the main driver of the Pound and the ECB's monetary policy decision on Thursday will be a key event for the Euro.

EUR/USD

The Euro is under pressure this morning as PMI data is expected to extend its decline. The pair is back towards year-to-date lows of 1.1107 and could continue to test this support level following today's data. The recent decline in the Euro has pushed the trade-weighted index to two-year lows.