The stakes are high for the Federal Reserve to continue tightening

Today’s news headlines:

  • ‘Trump administration will impose tariffs on USD200bn in Chinese goods’. The United States will impose a 10% tariff from 24 September on $200bn worth of Chinese goods, increasing to 25% at the end of the year. (CNN)
  • ‘Trump also warned in a statement Monday that if China takes retaliatory action against US farmers or industries, “we will immediately pursue phase three, which is tariffs on approximately $267 billion of additional imports’. (Reuters)
  • ‘Beijing likely to cancel trade US talks after latest round of tariffs’. (South China Morning Post)
  • ‘RBA minutes reiterate that next move in the cash rate is likely higher’. (Market News)
  • ‘We won’t let future PM unpick Brexit deal, vows Michel Barnier’. In a rebuff to Michael Gove, Brussels is preparing to demand that Theresa May makes ‘credible’ assurances that any deal will not be unpicked by her successor. (The Times)
  • ‘UK Brexit minister Raab expects EU to make concessions’. (Die Welt)
  • ‘Brexit: Theresa May says it’s Chequers or no deal’ The Prime Minister told the BBC that MPs will have a choice between her proposed deal with the EU – or no deal at all. (BBC)
  • ‘Ireland may face EU tax pressure in return for Brexit support’. Some EU members may press Ireland to drop its opposition to wide-ranging corporate tax reform in return for the bloc’s backing on Brexit. (Bloomberg)

Monday’s light economic calendar led to subdued trading in the European morning session with major crosses confined to narrow ranges. The Eurozone final revision of the August Consumer Price Index (CPI) confirmed 2% annual price growth in the currency union. Although inflation is now above the European Central Bank’s (ECB) target, the characteristically subdued underlying price growth continues to unnerve policymakers and justifies allowing inflation to overshoot target. Eurozone labour costs were still only 2.2% annually in the second quarter. The data reinforces our call that an economic slowdown and gathering downside risks will lead the ECB to delay hiking rates in September 2019. The market is pricing in 7 basis points of rate hikes by September 2019, meaning the market may be primed for disappointment and a lower Euro.

Dollar weakness dominated the Monday afternoon session, with the Greenback down against all G10 currencies by the end of the day. We noted interesting price action in the 10-Year US Treasury market as a potential trigger for the move. Long Dollar positioning remains at its most extended level since June 2017, and short US 10-year Treasury positions; market bets on continued Federal Reserve tightening are within a whisker of a historical high. Stretched positioning leaves the market exposed to a sharp reversal. The question is, does this Dollar downside move have any traction? US data has been continually disappointing, and the market is revising its expectations for Federal Reserve tightening or a more positive environment for risk (for example a resolution to the global trade war) which would allow the dollar to slide. As none of these potential triggers have yet been realised, Monday’s move is more likely a short-term aberration, but it shows where the pain lies.

The regional New York Empire Manufacturing survey was one of the earliest reading on the health of US manufacturing in the month of September and it wasn’t pretty. The headline index dipped to its lowest level since April 2018. A drop in new orders, building inventories and shorter delivery times suggest moderating demand and a gradual slowdown in manufacturing into year end.

Overnight, the Reserve Bank of Australia (RBA)’s September Meeting Minutes were hawkish at the margin as the Bank noted recent above-trend growth and a tighter labour market, allowing it to reiterate that the next move in the cash rate will likely be up. The RBA is trying to manage a slowdown in the housing market and a lack of core inflation pressures, with wage growth still slow.

For the day ahead, the US National Association of Home Builders’ (NAHB) Housing Market Index will be released. The index has trended lower since the start of 2018. The sector has been the exception of the US’s stellar growth, hampered by higher mortgage rates, higher input costs from lumber tariffs, and increasing affordability problems for home buyers. The July Treasury International Capital System report will provide insight into foreign holdings of US Treasuries. Canada’s July Manufacturing Sales will also be released.