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ECB and BoE Rate Decisions, New Territory in Trade Wars, Global Political Risks - DFX key themes

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JohnDFX

Important European Central Bank Rate Decisions

As we find distraction in trade wars and political risk, it is important to remember that we are still dealing with more traditional fundamental issues in the background. One of the most systemically important and extremely underpriced risks is the global market’s long-standing dependency on massive stimulus from the world’s largest central banks. That wave of easy money through massive rate cuts and largest stimulus programs has noticeably receded while recognition of more recent iterations of the collective effort have failed to earn the impact that it was pursued for: a return to steady inflation, faster economic activity and wage growth that outpaced the cost of goods. Instead, we are just left with the very effective but increasingly unwanted side effect of artificially inflated speculative assets. 

Eventually, this big-picture fundamental gap will be reconsidered by the investing masses; and if that occurs amid a financial unwind, it could readily turn mere risk aversion into full-scale panic. As we await the inevitable reckoning, we will take in two important monetary policy updates from major central banks on opposite ends of the spectrum: the Bank of England (BoE) and European Central Bank (ECB). The BoE’s policy meeting is not expected to deliver another rate hike, and anticipation for forecasting is likely rather restrained. Currently, swaps are pricing in less than a 50 percent chance that the central bank will hike rates again before mid-2019. Given that this is a group that has already hiked a few times and has inflation figures to justify further moves if Governor Carney and Co want a reason, this decision can help establish the outlook for global monetary policy as a baseline for economic expectations. 

Alternatively, evaluation of the ECB’s decision comes from the opposite perspective. The central bank is still employing its stimulus program but is expected to cut if off later this year. Following that, the expectation is for a rate hike to be triggered sometime mid-2019, but swaps currently put that outcome at a sparse 20 percent whereas a few months ago, it was supported by a more than 80 percent probability. Beyond just the rate decision and press conference, we are also expecting macroeconomic projections from the group. If one of the world’s most prolific (profligate?) policy groups deems the outlook does not deserve a steer away from crisis-level settings, what would that say about the health of the economy and financial system?  

Another Week in the Trade Wars

Another week and another escalation in the ever-expanding global trade wars. From the heaviest front of the economic confrontation, the period for public feedback on the Trump administration’s proposed $200 billion increase in tariffs on key trade counterpart China came to a close. It is not clear how quickly this will be turned from theory into action, but the markets certainly aren’t simply discounting this marked intensification of the trade war between the two super powers as mere bluster. As remarkable as this threat is on its own, President Trump wasn’t content to leave the heavy threat to linger in the air. On Air Force One, the ‘leader of the free world’ said he was in fact considering a further increase in the United States’ pressure against its rival to the tune of $267 billion. That is $267 billion in addition to the as-yet realized $200 billion. A few months ago, the President – following on the initial warning of the $200 billion jump – said he was prepared to tax all Chinese tariffs. 

With these successive programs, he would be taxing more than the United States total imports of Chinese goods through 2017 – over $517 billion with the $50 billion and metals taxes already in place versus $506 billion actually purchased. If we only realize the first massive slug of additional taxes, the retaliation from China will further complicate this situation. It will not be able to do a like-for-like retaliation as it will soon eclipse the total imports the country consumes from the US. Resorting to other measures to approximate can easily be construed by this administration as not just response but escalation. Meanwhile, not content to keeping the fight on one shore, the US failed to find a compromise with Canada in its ongoing negotiations to shore up – or more likely replace – NAFTA. If a breakthrough is found next week, the Canadian Dollar is still significantly discounted and could generate a hefty rally in response to the good news. And yet, settling the dispute for the North American trade partners will not raise much enthusiasm for the rest of the world. 

In addition to Trump’s threats to raise the bill on China, he also made a very thinly veiled threat aimed at Japan who the US is currently engaging in trade discussions. A ‘good deal’ for the US is likely one for which Japanese officials will balk at even with the obvious risk of having to engage in a trade war. On the bright side, the US and EU have not furthered their war of words (autos tariffs, accusations of currency manipulation, threats to circumvent the other’s currency for causing systemic trouble)  to one of action. Yet, considering much of this seems to move in cycles for who is targeted each week, give it time. 

Global Political Risk Always Simmering and A President That Lashes Out Under Pressure 

Political risks seemed to deflate in the US, UK and Euro-area this past week, but they certainly haven’t been resolved. Far from it. The coalition government in Italy is starting to run out of room for making commitments to both live up to campaign promises of increased government spending and checks on EU influence will simultaneously meeting obligations to control budget that will not send European officials and financial markets into a panic. From the UK, the Prime Minister Theresa May continues to find pressure from her government, cabinet and EU counterparts in navigating a Brexit negotiation that would somehow please all parties involved. This is ultimately impossible as the groups are in essence demanding outcomes that the antithesis of each other. 

What we are left with when trading the Pound is a sentiment that seems to oscillate regularly but keeps landing back into the realm of firm warnings to prepare for a ‘no deal’ outcome. In the United States, President Trump is continually bombarded by the news media with scandals that are coming dangerously close to the leader himself. His penchant for retaliating on social media and in rallies is doing the opposite of quelling the storm. In general, it is important to leave our own political beliefs out of our investing – and especially out of our trading (short-term). There have been both economic booms and recessions under both Democrat and Republican administrations – and through various combinations of Executive and Legislative concerns. 

However, political risks can spill into more immediate financial and economic issues which in turn can charge the market. Trump has said recently that he has considered shutting the government down again if Congress does not curb the rebellion against his agenda. There is also suggestion of a second tax cut being floated and we are still awaiting word that the fiscal stimulus promised on the campaign trail will be revived. What is particularly unique to the US President is his tendency to react to personal pressure from the Mueller investigation and news media’s general criticism with aggressive policy on other fronts. Would he have made the $267 billion threat of escalation against China this past week if the scrutiny over his actions were not so intense? It is difficult to argue that he is too level-headed for that retaliation against the world as there are too many examples to suggest the opposite.

 

USD price action ahead of ECB and BoE

 

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