ECB's Draghi remains optimistic

Today’s news headlines:

  • ‘China says US trying to force it to submit on trade as new tariffs kick in’. China accused the US of engaging in ‘trade bullyism’, the official Xinhua news agency said. (Reuters)
  • ‘Italy’s Di Maio says 2019 budget will scrap tax break for oil companies’. (Reuters)
  • ‘Navarro: China engages in so many ‘egregious practices,’ it’s tougher to get a trade deal.’ Peter Navarro, director of the National Trade Council at the White House, spoke about the difference in trade negotiations with Mexico and China. (CNBC)
  • ‘Trump signs revised Korean trade deal’. US President Trump signed a revised free trade agreement with South Korea on Monday in New York, cementing the first bilateral trade deal of his administration and suggesting the US could soon win similar agreements with other trading partners. (New York Times)
  • ‘UK to hold nerve after Brexit talks hit impasse: Brexit minister’. Brexit minister Dominic Raab said on Monday that Britain would not flinch in an impasse with the European Union after European leaders rejected Prime Minister Theresa May’s plans for leaving the bloc last week. (Reuters)

GBP failed to deliver follow through from Friday’s ‘no deal is better than a bad deal’ Sterling slide. Profit taking and the Sky auction which US firm Comcast won for USD39bln saw the pair moving higher from the European open. Despite the bounce, Cable was nowhere near retracing Friday’s price action and opens Tuesday around the 1.3108 level.

The main event in yesterday’s trading session was provided by European Central Bank (ECB) President Mario Draghi, who continued his surprisingly hawkish tone. Speaking at an ECON Committee meeting in Brussels, Draghi forecast a ‘relatively vigorous pick-up in underlying inflation’, pointing towards continued wage growth. The Euro gained 0.55% against the Dollar and rates markets raised their expectations for ECB tightening from six basis points to nine over the next year.

Eurozone labour costs have been on a broad upward trend since mid-2016. However, at 2.2% annual labour costs growth in Q2, wages may be heading in the right direction, but they aren’t getting there fast enough to support a sustainable move of inflation to target. Core inflation recorded only 1.0% in August, suggesting underlying price pressures remain characteristically subdued.

In his speech, Draghi mentioned a few of the numerous risks to the Eurozone – the sustainability of Italy’s debt, Brexit, increased protectionism that is hitting the Eurozone manufacturing sector, and emerging market turmoil leading to Euro appreciation on a trade-weighted basis. And yet, risks were still ‘broadly balanced’. If any of these risks crystallise, the ECB would have to backtrack on its guidance for beginning to raise interest rates from September 2019. Given market expectations for monetary policy, this would lead the common currency lower on reduced rate support.

Yesterday’s afternoon brought the news that the US may hold more talks with Turkey on US pastor Andrew Brunson and that he could be released this month. The news from US Secretary of State Mike Pompeo provided the Turkish Lira with a temporary reprieve, with USD/TRY trading down to 6.05 only to retrace overnight.

Tuesday, the first main release of the day is the Federal Housing Finance Agency House Price Index. US house prices continue to march higher, adding to affordability concerns in the sector. The index showed some signs of deceleration in the second quarter. Surveys show that consumers view high house prices as the worst condition for buying since October 2006, right before the crash. The Richmond Fed Manufacturing Index is expected to show slight moderation in activity in US mid-Atlantic factories after a six-month high in August. US Conference Board Consumer Confidence is forecast to moderate in September after reaching a cyclical high in August. The index suggests that consumer demand is in no danger of slowing and the jump in the income expectation sub-index suggests wage pressures are coming.

Tuesday has a full speaker schedule, so headline risk will be key for markets. The ECB’s Chief Economist Peter Praet will deliver the opening remarks at a summit titled ‘Rebalancing Return and Risk Amid Global Recovery’. Uber dove Gertjan Vlieghe of the Bank of England (BoE) delivers a speech with a Q&A session before the ECB’s Praet is up again speaking on the low interest rate environment and consequences of unwinding asset purchases. The ECB’s Benoit Coeure, usually a more dovish board member, chairs a research conference.