Posted on: 11 Jul, 2019
The recovery in the US inflation print, while it does not carry the substance necessary to shift the Fed’s narrative, it nonetheless makes the possibility of a 50bp rate, now priced at 21%, hard to imagine. The Fed will probably want to save further ammunition for months to come.
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The follow-through USD buying in the last Asian session, on the back of Fed’s Chair Powell cementing the case for a well-framed 25bp ‘insurance rate cut’ on July 31st, gave the impression that further pain was ahead for the world’s reserve currency this Thursday.
Until the US CPI came about with a meritorious printing in core inflation terms, at 0.3% m/m, which happens to be the largest gain in over one and a half year. A positive trend in the USD through American hours then ensued as the market was caught wrong-footed.
The recovery in the US inflation print, while it does not carry the substance necessary to shift the Fed’s narrative, it nonetheless makes the possibility of a 50bp rate, now priced at 21%, hard to imagine. Today’s print is the type of number that should solidify a precautionary approach in the Fed’s easing, read no 50bp rate cut, as it allows to buy time to gather further evidence on how the US economy fares the trade-related headwinds before using up further ammunition. The dual strong numbers in US payrolls and now core CPI, even if the relationship between inflation and unemployment is gone (Phillips curve theory), adds to the case.
As a reminder, the Fed’s 2% inflation target mandate, takes into special consideration the core personal consumption expenditures (PCE) price index as their favored gauge to set policy. This particular measure did only increase by 1.5% y/y up to May, clearly undershooting its target. If further reassurance is needed that Powell won’t blink after today’s core CPI, this week he said: “there is a risk that weak inflation will be even more persistent than we currently anticipate.”
The major pain in the neck for Fed’s Powell is, first and foremost, managing such an uncertain landscape amid the real prospect that a no trade deal with China entails for business confidence and the ripple effects it can create, until now, to a solid US economy.
That's precisely why, the voice of the Fed, heard through a big line up of Fed members today, seemed to keep a consistent narrative that accommodation is coming.
As part of Fed's Chair Powell testimony to the Senate today, the policymaker touched on the fact that businesses are starting to hold back on investment while adding that many of his colleagues in the Fed “have come to the view that a somewhat more accommodative policy may be appropriate.”
Richmond Fed president Tom Barkin was the boldest by expressing the view that “if you decide to do something on rates, better to move faster than slower.” Meanwhile, Fed's Williams semantics were more akin to the central message Powell has aimed to deliver all along this week, with Williamd saying that “the current picture is complex, but the economy is still in a good place.”
In the meantime, and shifting gears, the markets are slowly but surely coming to terms that the last 10% US economic adviser Kudlow was referring to, the final sticking points still to be agreed with China, is a bumpy road with neither China nor the US boasting optimism as things stand.
From the US side, today’s daily fix by President Trump on Twitter, as always characterized by talk without mincing, notes that China is letting the US down by not buying agricultural products.
China seems to also be calculating every move it makes in reference to trade talks with surgical precision, and Thursday’s comments via China's commerce ministry, were as lame as it gets, simply noting that both sides are working to implement consensus.
Until proven wrong, the market has been behaving with skepticism ever since the trade truce, and so far there is devoid of details that makes one think there can be some breakthrough as both leaders can’t afford to show signs of weakness that may undermine their credibility.
And if you thought the waters were not turbulent enough, Politico reports that U.S. officials are now pushing for sanctions on China over oil purchases from Iran.
“China defied U.S. sanctions when it imported more than a million barrels of crude oil from Iran last month. But they are grappling with whether — and how — to hit back, according to three U.S. officials.”
However, in the grand scheme of things, the US is still in a rather privileged position, not only sustaining a record-long economic recovery but with enough firepower to combat the risks of a slowdown. That ability to maneuver policy tool must sound like ancient times to the ECB, which fleshed out further evidence in today’s accounts of its June monetary policy meeting that show the governing council is finding broad-based consensus on the need to prepare for policy easing.
In the case of the ECB, it looks like the timing to pull the trigger on more stimulatory policies could really come any months, including July. It really is a tricky one as some ECB observers argue to collect more evidence (Q2 GDP in August, ECB staff projections) before delivering more easing via a tentative 10bp rate cut in the deposit facility or a resumption of the QE program as immediate actions to stimulate the lackluster state of the EU. If history is any indication, and Draghi aims to be, as he’s done in the past, ahead of the curve, July is also a real possibility.
Not that we needed more red flags to be raised about the precarious state of the Eurozone, but the IMF released an update saying that the single currency union faces a prolonged period of anemic growth and inflation, weighted by trade tensions, Brexit and Italy's piling debt.
With regards to Brexit, I’ll touch briefly, just to update readers that based on a Guardian survey, it all seems to indicate that Boris Johnson will receive enough votes to win the PM runoff. The new Prime Minister is due to be announced on July 23. It’s all in wait-and-see mode for now.
I won’t be leaving references to the UK yet, even if the next piece of news, is, as the paragraph above, hardly surprising. The Bank of England, as part of its latest financial stability report, reiterated that the risks to a global outlook deceleration have increased while warning that the perceived likelihood of no-deal Brexit has risen. It will all depend on how the process of Brexit negotiations plays out before the deadline by the end of October. What’s starting to have more rationale is a complete removal to any references to a hiking cycle and the introduction of gradual hints to ease, in line with the global trend seen, if headwinds prevail.
The lay of the land in FX indicates a Euro index (equally-weighted vs seven other currencies) in no man’s land after finding a tremendous amount of buying interest at what I consider to be the most relevant area of support for years. If every time the EUR index came to test this line of support one shifted its bias to short-term EUR longs vs the weakest currencies at the time, the precision to enter around inflection points for price was second to none as the chart shows. Now, once again, buyers are looking to engineer enough buy-side pressure to move it away from it.
With regards to the USD index, when cross-referenced vs seven currencies, it displays a bearish market structure with support found at the previous daily swing high. There is no reason to get overly bullish on the currency until more technical evidence is gathered. One could argue that on a micro scale the price is still on a short-term uptrend, but the descending trendline definitely caps the outlook at a more macro level.
The JPY index has printed a bearish candle (pin bar), which tends to see follow-through continuation if the context is ripe for it. By analyzing intermarket flows and the current market structure, Thursday’s price action does suggest the risk for further downside is building. At the bare minimum, the dual rise in stocks and bonds in the US justifies a retest of the recent swing low.
As I posted on Twitter earlier today, it does pay off to stay in constant sync with intermarket flows to avoid trading reactive but rather from a position where planning and anticipation take center stage. That’s why I encourage you to incorporate this branch of analysis with the JPY being the most intertwined currency when cross referenced to risk sentiment in the market.
The commodity-linked currencies, meanwhile, continue to benefit from the risk-positive flows in the market, especially the AUD and NZD as both Central Banks (RBA, RBNZ) don’t seem to hold the imminent easing urgency as they had in the previous month. The CAD, with a rather neutral statement by the BOC on Wednesday, still retaining the guidance of rates on hold as warranted, is finding overpriced pockets of demand that keeps the currency underpinned.
Lastly, the GBP remains in an unambiguous multi-month bearish trend, unable to retake its 13-ema baseline since May 7th, more than 2 months. The uncertainty over the Brexit process with the prospects of Boris Johnson as the next PM by the end of this month, and the ongoing economic weakness in the UK, have been the nail in the coffin to lack any love.
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