ECB Didn’t Live Up to Lofty Speculation, Will the Fed?
There is a span of high-level rate decisions this coming week, but only one of these updates carries serious potential to not only move its domestic assets but further potential to generate reaction from the entire financial system: the FOMC. This past week, the European Central Bank offered us a look into how far the dovish reach of the largest central banks is currently stretching. Against heavy speculation that the group was going to clearly lay out the runway to further rate cuts and escalation of unorthodox policy, they instead offered a more reserved view of their plans. Fending off an approximate 40 percent probability of another 10 basis point rate cut, the ECB held rates and offered up language that said they expect to keep rates at their current level “or lower” through the first half of 2020. On a full swing back into stimulus – versus the half measure of the TLTRO – President Draghi said they were looking into options. There is complication in the ECB pushing ahead with further accommodation as new leadership is coming in a couple months. This seems to concern them more than the risks that their increasingly extreme measures risk degrading the efficacy of monetary policy all together, particularly risky in the event that we face another global slowdown or financial crisis.
The swell in European investor fears about the prospects for the future may be soothed by an outside wind if it proves timely and fully supportive. According to the market, the Federal Reserve is certain to hike rates at its meeting on Wednesday. Fed Funds futures are forecasting a 100 percent change of a 25 basis point (bp) cut and is reaching further to an approximate 25 percent probability of a 50 bp move. That is unlikely. Under scrutiny from the President and the markets, the Fed is attempting to signal its consistency as it works to reinsure its credibility. In the June Summary of Economic Projections (SEP), the median forecast on yields was for no change to the benchmark this year. A 25 bp cut at this meeting would not deviate too far from their assessment as the dot plot showed at least 8 members expected at least one 25bp cut (1 anticipated two), so it was a close sway in majority. That said, 50 bp against a backdrop of data that has performed well and equity markets are records would send the wrong signal: either one of hostage to fear of volatility or a sense of panic that they are not sharing about the future. How much is the markets banking on the Fed to converge with its much lower yielding counterparts? That answer will likely spell how much volatility we should expect.
Donald Trump Throws a Curve Ball on Trade Wars
Fear over trade wars had receded recently as confusion seemed to replace the tangible pain of tactical threats. Between the US and China, headlines were more about the next round of talks that were being conducted at a high level in China while trouble over the status of Huawei and the retaliation that could bring was fading out of the news cycle. We almost cleared the week with a ‘no news is good news’ perspective when President Trump decided to weigh in on something the market had long suspected was a strategy but presumed would never be made certain by officials. In offhand remarks that suggest he does not appreciate the fear that can be easily sparked in speculative markets, Trump said China may not agree to any trade deal until after the Presidential elections in November 2020. That may very well be China’s strategy: wait it out until a more amenable administration potentially takes over. That said, the Chinese economy has already taken a significant blow from the standoff thus far. It is unlikely they would want to keep it up that long on the chance of turnover. This may also reflect a Trump administration tactic: refuse to compromise out to the election and use it as a campaign point that no other government would be able to close the deal. Either way, this is a concerning musing.
And, in the meantime, don’t forget that there is pressure building up on other fronts. For the United States, the question of open trade war with Europe seems to be graining tangibility with the theorizing of explicit moves from both sides for a variety of perceived infringements including the Airbus-Boeing spat. The most costly threat though remains the potential that the US is considering a blanket 25 percent tariff on all autos and auto parts which could encompass many countries but carry the most pain for Germany, Japan and South Korea. Speaking of those latter two, there is an Asia-specific trade war burgeoning between Japan and South Korea with the former threatening the supply materials necessary for the latter to produce computer chips. And, though it isn’t often considered a ‘trade war’ front, the UK-EU divorce carries with it clear trade disruption implications that will compound a global figure in collective trade.
Another Verse in Milestone Towards Currency Wars
Most business leaders and financiers publicly project a confidence that the world faces little or no risk that a currency war could erupt between the largest economies in the world. Privately, they are very likely worrying over the pressure building up behind active measures to devalue currencies and setting off a chain reaction of financial instability. It isn’t a stretch to suggest certain major currencies are artificially deflated, but most instances are not this way intentionally (for the purpose of economic advantage over global counterparts) or have been implemented recently. The ECB deflated the Euro with direct threats of monetary policy back in 2014 when EURUSD was pressuring 1.4000. Japanese officials slipped up before that when they suggested they are pursuing their open-ended QE program in an effort to drive their currency lower to afford a trade advantage. They later back-tracked and now simply say their ceaseless JGB purchases are a bid to restart inflation, which has floundered for three decades. The Swiss Franc is faced with constant intervention threat by the SNB, but their efforts are tied to the Euro and ECB’s overwhelming stimulus drive.
In most instances around the world, policy officials are attempting to account for missing their stated policy goals (such as inflation) or offset external pressures that are themselves the results of a collective unorthodox policy epoch. However, in this desperation, there is increasingly an assumption of malicious intent from trade partners. President Trump is certainly suspicious of global counterparts. He reiterated his concerns this past week in something of a different light. Seemingly facing pressure by advisers for his frequent lamenting of the strong Dollar being interpreted as a ‘weak Dollar’ policy, the President said the Greenback is still the currency of choice – which he supports – while the Euro wasn’t doing well and the Yuan was ‘very weak’. That still looks like intent. What is troubling were the reports that trade adviser – and noted extreme China hawk – Peter Navarro had presented a range of ideas to possibly devalue the Dollar to the administration. They rejected the ideas, but the fact that this is taking place at all certainly raises the threat level of a currency war extremely high.