This week’s market: Brexit, ECB, China trade
The week now ending has been dominated by two long-running themes, the Brexit debacle and the US-China trade tiff.
The market behavior with regards to GBP is somewhat contradictory. On the one hand, cable has rallied sharply on the increasing possibility of a delay in Brexit, which could leave time for an election or another referendum that could reverse the whole process. On the other hand, the GBP/USD risk reversals have been heading down sharply, indicating that while people are buying the pound, they are also buying insurance against a possible fall in the future. That suggests they don’t have 100% confidence in their trade, which I can imagine – politicians who were crazy enough to get themselves into this situation cannot be relied upon to act responsibly and rationally in the future, either.
ECB President Draghi’s press conference was more dovish than the market expected (although not for readers of this comment!) The key point was that whereas in December he had described the risks to the Eurozone economy as “broadly balanced” but “moving to the downside,” this time around he said the risks “have moved to the downside” due to “uncertainties related to geopolitical factors and the threat of protectionism, vulnerabilities in emerging markets and financial market volatility.” These are the same issues he had mentioned last time; apparently they’ve taken a turn for the worse since December. Accordingly, the market moved down (slightly) the likelihood of a rate rise this year and moved up (slightly) the odds of a rate cut.
With the ECB and the Fed now apparently both on “pause,” it remains to be seen what the new impetus for EUR/USD is going to be. I think the trade issues and Brexit will begin affecting EUR more strongly from now on.
As you can see, the overall Eurozone trade surplus is basically the same as the German trade surplus.
And German exports are already suffering from Brexit. With a further slowdown in imports in Britain, plus possibly tariffs on autos sold in the US, plus the slowdown in China (imports -7.6% yoy in December), the likelihood is for a further slowdown in export growth in Germany aka Europe, leading to a further slowdown in the Eurozone economy. As we saw this week, that’s enough to make ECB President Draghi and his colleagues more cautious and probably to delay their normalization of policy further. That should weigh on the euro going forward.
In that respect, the ongoing US trade dispute with China will continue to be a major market-affecting event. On the one hand, further. US Commerce Secretary Wilbur Ross said that the US and China were still “miles and miles” apart on trade and won’t sign a agreement anytime soon. Chinese Vice Premier Liu He is scheduled to visit Washington next Wednesday and Thursday to meet U.S. Trade Representative Robert Lighthizer. However, Ross has warned not to expect any breakthroughs at that meeting. So far, the ups and downs of the trade dispute have mostly caused a “risk-on, risk-off” mood that affected AUD and JPY foremost, CAD and CHF secondly (and maybe NZD). But going forward, I think it will start to impact EUR more – negatively – as people realize that the Eurozone economy is more vulnerable to a downturn in global trade than the US is.
This week: FOMC, ADP, NFP (maybe), Q4 GDPs
We’re really going to feel the impact of the US government shutdown this week as several major US indicators probably won’t be published, namely Q4 GDP, the personal consumption expenditure (PCE) deflator (the Fed’s preferred inflation gauge), and the rock star of the US economic statistical world, the nonfarm payrolls (and its sidekick, the actually more important average weekly earnings).
The FOMC is unanimously expected to be on hold when it meets Wednesday. In fact, the market sees only a 23% chance of a rate hike by September, and if they don’t hike by then, they think the chances of rate hike during the year are likely to decline. In fact, it doesn’t show up on this graph but the market odds of a rate cut by December are almost the same as the odds of a rate hike (17.3% vs 18.1%).
Since the December meeting there have been so many speeches by so many FOMC participants that I wonder whether we will actually get anything new from this meeting. The lack of US economic data will further cloud the view. I think the most important information will be in the press conference following the meeting. From this year on, the Fed Chair will hold a press conference after every FOMC meeting, not just every other one. The key point will be Fed Chair Powell’s take on the economy and especially the impact that the long-running government shutdown will have on the economy and on the Fed’s decision-making process. They’ve said that rate hikes would no longer be automatic but rather would depend on the data – but how will they manage without much of the data?
As for the data, usually I’d be going on and on in this comment about the nonfarm payroll (NFP) data, but while there is a consensus forecast out for it, there probably won’t be a release. That leaves the ADP report as the big event of the US calendar. Automated Data Processing Inc. (ADP) is an outsourcing company that handles about one-fifth of the private payrolls in the US, so its client base is a pretty reliable sample of the US labor market as a whole. Its report is usually used as an indication of what that week’s NFP figure is likely to be – this week it may be a proxy figure.
The market is expecting a somewhat below-trend 165k, but that’s only natural after last month’s above-trend 271k. This month’s estimate would bring the 6m moving average back to 200k, which is pretty much where it was before the December outlier. In other words, the market is expecting reversion back to trend – quite a typical forecast, and one that would be neutral for the dollar.
In the absence of much of the official data, the Institute of Supply Management (ISM) manufacturing PMI is likely to be another highlight this week. It’s forecast to be unchanged, in contrast with the Markit PMI out this week, which was up slightly. An unchanged reading would probably feed into the FOMC’s “pause” narrative, in that it implies continued expansion but not necessarily any acceleration – no need to change policy. USD neutral
We’ll also have several important indicators out from Europe this week. We get the Q4 GDP data and the German & Eurozone CPI figures.
The French GDP figures come out on Wednesday and then the first estimate of Eurozone 4Q GDP on Thursday. The figures are likely to see qoq growth continuing on at the rather sluggish pace of Q3, which means a notable deceleration on a yoy basis. That should confirm ECB President Draghi’s conclusion that “the near-term growth momentum is likely to be weaker than previously anticipated” and justify his cautious view on growth. EUR negative
Similarly, while the German headline inflation number is expected to accelerate slightly, Eurozone-wide headline inflation is expected to decelerate sharply, confirming Draghi’s comment that “headline inflation is likely to decline further over the coming months.” The core CPI, which is what the ECB targets, is forecast to show the same yoy growth rate still well below the ECB’s 2% target. That hasn’t budged much – since May 2017 it’s basically fluctuated in a 0.9%-1.1% range, with just one or two exceptions. “ Looking ahead, underlying inflation is expected to increase over the medium term, supported by our monetary policy measures, the ongoing economic expansion and rising wage growth,” Draghi said. We eagerly await evidence that this is true, but don’t hold your breath.
All in all, I would expect the week’s data to confirm the ECB’s dovish turn and to confirm people’s expectations of no change in rates this year – or even a possibility of a rate cut. At the same time, the figures should also demonstrate that the US economy is holding up well and continuing to expand, which may cause people to reprice their expectations of no change in rates this year (after all, the FOMC was predicting two rate hikes not so long ago). That “monetary policy divergence” is likely to push EUR/USD down during the week, in my view.
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