Leaving the Eurozone swamped
Today's news headlines:
- ‘China, US are showing a little goodwill as trade talks near’. The US and China have taken small measures to help ease trade tensions ahead of upcoming negotiations in October. Yesterday, Trump announced the increase in tariffs from 25% to 30% would be postponed by two weeks to 15th October 2019. Meanwhile, China will exempt 16 categories of US goods from the 25% tariff implemented last year. Despite being a move in a positive direction, the gestures are slight in comparison to the overall tariff structure, and both parties still disagree on fundamental issues. (Bloomberg)
- ‘UK’s worst-case no-deal Brexit plan warns of food shortages, public disorder’. The government’s ‘Operation Yellowhammer’ worst-case Brexit scenario assumptions were published on Wednesday, warning that public and business preparation would be low, in part due to political confusion in the run-up to the Brexit date. The listed disruptions include cross-Channel routes affecting the supply of medicines and fresh foods, and nationwide protests. (Reuters)
Grasping at straws
The analogy is apt; the last European Central Bank press conference of Mario Draghi’s tenure is set to be an exciting event, but today’s policy action is like plastering over a water leak, it’s the wrong solution and likely to leave you swamped. Fortunately, there is now broader acknowledgement that fiscal policy has been virtually absent from the fight against disinflation and more needs to be done.
German Finance Minister, Olaf Scholz, has promised billions of Euros in spending in the event that Germany enters a recession. In one sense, that’s good news because it suggests the government isn’t oblivious to the impacts of their miserly fiscal policy, but it also indicates firm opposition to proactive spending. The problem, of course, is that many developed economies find themselves in a similar position, so if we imagine some prospective investment via the fiscal policy channel in a single country, it will have a disproportionately modest impact both domestically and on the global system.
Let’s also be clear here; there is a big difference between deficit spending and balanced spending, i.e. not accruing surpluses. The quality of investment also has a big impact. A large infrastructure investment in Germany would have a positive effect even if it were deficit spending, while a capital gains tax cut in the US isn’t a good use of cash regardless of the state of the budget.
Now that we’re witnessing regular conciliatory gestures from both sides of the US-China trade dispute, hopes are rising that a trade deal might be close and reawaken animal spirits (a collective bonhomie which encourages confident spending and investment). We would argue that this improved sentiment would be greatly diminished by the protracted and unchecked political uncertainty, which has pervaded 2019. The damage may already be done, and a return to the heady days of 3.0% GDP growth will require some intelligent policy choices and courage across the developed economic world.
Bottom line: The ECB policy announcement is being hyped quite strongly at the session open. Estimates were for a 0.15% cut in the deposit rate, tiering to shield 30% of bank collateral from the additional interest rate charge and 45bn EUR per month of asset purchases for 12 months. That’s a significant shift in expectation from a few weeks ago and sets the stage for disappointment, which may result in EUR appreciation in the short-term.
Yesterday’s session was flat, fluctuating less than 50 pips throughout the day as a suspended Parliament limited developments in the Brexit story. The pair has so far held onto September’s rally above 1.23, with support at the big figure.
Today’s European Central Bank (ECB) monetary policy announcement will likely be the main driver of the pair as a suspended Parliament has lowered Sterling volatility. The pair has traded in a tight range following Monday’s climb above 1.12 and has short-term resistance at 1.1230 and support at 1.1150.
The common currency has rebounded on the London open following yesterday’s dip in anticipation of the ECB’s monetary policy announcement. The Euro is likely to be volatile this afternoon as details of an unknown stimulus package from the ECB may emerge. A large stimulus package may already be priced into the Euro, which would mean greater risk to an upside move than a downside move if the ECB disappoints.
All content is written by the Global Reach Trading Desk. The opinions expressed are not the view of Global Reach Group and are not intended as investment advice.