Reducing the majority

Today's news headlines:

• 'Boris Johnson's UK majority cut to one after special-election defeat'. Yesterday, the pro-EU Liberal Democrat Party won a by-election in Brecon and Radnorshire, reducing Johnson's Parliamentary majority to a single seat. The result strikes a blow to Johnson's strategy to leave the EU by October 31st 'come what may'. He'll need every vote he can get if he's to get a new deal through Parliament. (Bloomberg)
• 'US factory gauge sinks to lowest since '16 as exports drop'. Slower production and weak export markets have resulted in a three-year low in US manufacturing activity. The ISM Manufacturing PMI fell to 51.2 in the fourth straight month of declines, inching closer to an outright contraction in the sector. Global manufacturing in the Euro area and China have both been hit by weakening demand and trade policies that have left some supply chains in disarray. (Bloomberg)

Taxing the hell out of China

Yesterday, US President Donald Trump announced plans to place 10% tariffs on $300bn in Chinese goods imported into the country. The abrupt Tweet announced that from September 1st, US tariffs will come into effect due to a lack of progression in trade negotiations. These new tariffs directly impact the consumer goods market as we expect cell phones, laptops, clothing, and children's toys all to be hit. Trump's move could shatter the fragile trade truce, which resulted from the G-20 meeting with Xi in Osaka, and this has been reflected in the immediate market reaction. The S&P 500 fell to its lowest level since June and oil prices declined by 7.0%. US Treasury yields also dipped on fears that the Federal Reserve would soon have to cut interest rates again. The safe-haven Japanese Yen found itself close to year-to-date highs, and the offshore Yuan lost over 1.0% of its value against the Dollar.

This new development in the trade arena threatens to weaken an already-slowing global economy and raises the potential for future central bank stimulus. Bloomberg economics indicates that tariffs at the projected level would cut 0.4% of US Gross Domestic Product and 0.6% of Chinese growth by 2021. We would expect to see further easing from the Federal Reserve and the Peoples Bank of China as neither economy is as well placed to absorb these headwinds as in previous years. We also expect China to try and slow down the pace of negotiations further while responding with tit-for-tat retaliation. This could last until the upcoming US election in the hope that Trump will be defeated by a democratic rival—one that is not prepared to hold the global economy hostage in achieving a trade deal.

Bottom line: The threat of new tariffs exposes Trump's impatience in trying to get China to agree to a deal before the election season. The indication that China is prepared to wait out the tariffs means that Trump's latest gamble could do little more than inflict pain on US consumers and businesses, along with forcing the Fed into another ineffectual rate cut.

Fed's first test

Today's US labour market data is a chance for the Federal Reserve to justify Wednesday's hawkish insurance interest rate cut. When the Fed turned dovish earlier this year, questions were raised over how much interest rates would be cut and whether this would be the beginning of an easing cycle. Fed chair Jerome Powell claimed the 0.25% cut is simply a 'mid-cycle adjustment', emphasising that downside risks to the US originate from abroad and not from the domestic economy.

Today's highly-anticipated US Non-Farm Payrolls and wage growth data for July could take some pressure off the Fed and relax market expectations of further policy easing. The payroll data point is expected to read 165k, which is approximately the average reading for the last two-years of the record US economic expansion. Furthermore, wage data is expected to remain robust, growing 0.2% month-on-month.

The significance of today's data is heightened following Trump's aggravation of the trade war with China. As downside risks from abroad grow, US economic strength must keep up if the Fed is to anchor expectations of its monetary policy stance.

Bottom line: When the hawkish insurance rate cut occurred on Wednesday, the Dollar Index rallied to two-year highs, and the stock market dipped from all-time highs. A strong labour market reading may produce the same result since the outcome would support the Fed's decision.

Source: Bloomberg

GBP/USD

Cable dropped to a 30-month low yesterday, slipping to the 1.2080 level at one stage, as the Bank of England reduced forecasts for UK economic growth. The trade-weighted Dollar Index hit two-year highs but found some selling pressure after the disappointing ISM Manufacturing PMI reading.

GBP/EUR

The pair traded in a tight 40pip range yesterday as European manufacturing data came in roughly where expected. Both the Euro and Sterling trade-weighted indices are at the lows of their respective ranges, providing a lack of direction in the immediate-term.

EUR/USD

Downside pressure is in evidence as the pair trades below the 50, 100, and 200-day moving averages. Thursday's two-year low of 1.027 will act as key support before we start looking back to the 1.0960 and 1.09 levels dating back to 2017. The fall in Treasury yields resulting from renewed trade tariff threats has also weighed on the Greenback.

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.