A possible hawk among the doves
Today's news headlines:
- 'Sacking of Turkish central banker sparks concern'. Turkish President, Recep Tayyip Erdoğan, fired central bank Governor, Murat Çetinkaya, in a move highlighting the bank’s lack of independence. Not surprisingly, the Lira took a hit afterwards. (Financial Times)
- 'Greece's centre-right on course for snap election victory'. Kyriakos Mitsotakis' New Democracy party beat out the reigning Syriza party by a margin of 39.7% to 31.6% in Sunday's election. Mr Mitsotakis' focus will be on slashing taxes, reducing red-tape, and finally tackling youth emigration. (Financial Times)
Downside Dollar risks build
The accumulation of downside risks to global growth has caused central banks to shift to a dovish policy stance and triggered a unified rally in bond and equity markets. In recent weeks, Fed futures markets have been pricing in multiple interest-rate cuts from the US before the Federal Reserve confirmed it’s considering action in the second half of 2019. The trend has pushed US 10-year Treasury yields below 2.0% for the first time since 2016 as well as elevating the S&P 500 to an all-time high.
The biggest risk to these markets right now is that the Fed’s interest rate path doesn’t follow expectations, and Friday’s strong US employment data appears to have increased this risk. Futures markets are now pricing a more modest 27 basis point cut, down from 33 basis points last week. Fed chair Jerome Powell will deliver a speech on Tuesday along with his semi-annual monetary policy report on Wednesday. Sentiment from these along with Thursday’s US inflation data can make-or-break the sustained US bond and equity rally. If the case for no change in monetary policy builds, a sell-off is likely, and pressure on the US Dollar will build.
Bottom line: Fed chair Jerome Powell along with US inflation data will be key as markets assess the likelihood of upcoming rate cuts. Monetary easing has been largely priced into equity and bond markets, and any upset can trigger widespread sell-off. The risk that the US Dollar Index tumbles over the coming months is building…
The UK is no closer to leaving the EU with an orderly exit on October 31st, and political uncertainty is having a damaging effect on both the Pound and the British economy. The Sterling Index has lost over 5.0% of its value since the beginning of May and almost 2.0% since Theresa May resigned as Prime Minister. Confidence levels in manufacturing, construction, and services have all fallen with new orders in the service sector grinding to a halt. The signs point towards flat growth in the second quarter with underlying economic conditions unlikely to increase in the near-term. The appointment of Boris Johnson as PM has taken on a tone of inevitability in recent days, as a YouGov poll indicated that 74% of Tories would back him over Jeremy Hunt. As we know, Johnson has vowed to take Britain out of the EU ‘do or die’ on October 31st.
The prospect of Boris Johnson as the next leader of the UK is the predominant reason for a divergence in expectations between markets and the Bank of England (BoE). Markets are increasingly pricing in an interest-rate cut due to the likelihood of a disorderly exit. Yet, the government’s stated policy is to leave with a deal, meaning the BoE’s projections must account for an orderly transition. It’s a difficult situation for the BoE to counter, and it may consider producing a separate set of forecasts for a no-deal outcome in its forthcoming projections on Aug 1st. Another option is to project a much brighter outlook for the Pound and UK economy on the assumption of a deal; however, this may be considered too hawkish at a time when other central banks are turning dovish.
Bottom line: The prospect of either a no-deal or an extension to the Brexit deadline reduces the outlook for the UK economy in the near-term. Markets may continue to ignore the BoE’s official guidance if deemed unrealistic to current conditions.
Friday's surprisingly strong US payrolls number caused a Dollar rally, driving the Greenback to resistance at the trade-weighted 200-day moving average. Gradual depreciation of the Pound continues unchecked. On Friday, the pair broke through June lows and looks likely to continue.
Last week the Euro was sold off as a result of Dollar appreciation, while Sterling continues to drift lower. The net result for the pair is very little, and a sparse economic calendar for the next two days is unlikely to change that.
The strong US employment data has caused the pair to break both 100 and 50-day moving average support levels. Markets will be eyeing tomorrow’s Fed speakers to determine if wage data has changed the Federal Open Market Committee's (FOMC) policy path.