Inflation by the wayside

Today's news headlines:

‘France and UK face showdown with US over tech tax plans’. A new point of trade tension between EU and US may be coming to the fore. Britain and the EU are in discussions to implement a digital tax on big technology companies, which is highlighting stricter treatment of predominantly US tech companies. (Financial Times)
‘BoE steps up warning on no-deal risk’. The Bank of England (BoE) warned of serious economic disruptions in the event of a disorderly Brexit. They went on to state that UK banks had sufficient capital and the BoE had measure prepared against the possibility of a disruption, but neither would preclude an economic shock. (Financial Times)

The supply side

Extension of the OPEC+ supply cuts for the previous 9 months have helped stabilise and support crude oil prices, establishing a more consistent supply dynamic for the key energy commodity. However, new factors are changing this dynamic. A good deal of the agreed supply restriction is based on reduced production from Iran and Venezuela; a reasonable bet given the increasingly acrimonious Iran/US dialogue. The coordinated supply restrictions of petroleum exporting countries in late 2016, led by Saudi Arabia and Russia, was sufficient to lift energy out of the 2014 -2017 supply glut, where price reached a low of $28/barrel.

Following a rebound from the December 2018 equity sell-off, which also caused oil prices to sell-off, Brent crude seems to have found a more consistent trading range. The increasing prominence of global growth concerns in domestic economic discussions (see Jerome Powell’s Testimony to congress) has weighed on prices and tightened the trading range to $60-65/barrel. Certainly, more constrained and consistent energy prices are helpful to control imported inflation for the majority of nations who aren’t substantial producers, like the UK. The report of Hurricane Barry’s path through the Gulf is set to deliver a hit to supply, and potentially push prices up once again. This is not welcome news when growth is slowing, and rising energy prices act as a limitation to economic expansion.

Fed to still ease despite strong core inflation

Inflation figures in the US have disappointed throughout the first half of 2019, as the Consumer Price Index (CPI) has failed to consistently meet the Federal Reserve’s (Fed) 2.0% target. As indicated by Jerome Powell’s testimony over the past two days, persistently weak inflation has been a factor in the Fed’s shift towards a bias of monetary easing in July.

Ironically, core CPI for June beat expectations despite Powell’s admission that a return to the Fed’s inflation target “would take longer than previously projected”. Firmer underlying inflation shouldn’t be enough to stop the Fed cutting rates in their July meeting and Powell’s colleagues have reinforced this point. New York Fed President, John Williams, stressed that the argument to ease had strengthened and the bank would do all they could to extend the US’s record economic expansion.

Bottom Line: Firming inflation has the potential to leave markets scratching their heads over the future path of interest rates. Interestingly, global risk factors seem to have had more of impact on domestic price pressures in recent times. As we’ve not yet seen any subsidence in these risk factors, markets have continued to price in extended interest rate cuts.

GBP/USD

Yesterday, the Greenback continued to sell off albeit at a modest clip, now that July easing is near certainty. Sterling is unchanged despite dire no-deal warnings from the BoE. With a relatively quiet end to the week, Dollar is determining the pair.

GBP/EUR

Mirroring the Dollar, the common currency had a tamer day yesterday. A Eurofin meeting held today might provide some commentary surrounding fiscal policy in the bloc. Certainly, the French finance cadre had made some noises last week which suggested German purse strings required loosening.

EUR/USD

A slight uptick on pair commensurate with minor US loses/Euro gains. The Dollar is key driver heading into the weekend, though little is expected to drive volatility before a slew of Chinese data in Monday pre-trading.