FOMC – “Mid-cycle adjustment” but not rate cut cycle; US – China talks to continue in Sep; Stronger Aussie CPI sees RBA in watch and wait mode

FOMC – “Mid-cycle adjustment” but not rate cut cycle; US – China talks to continue in Sep; Stronger Aussie CPI sees RBA in watch and wait mode     

• A “hawkish” Fed 25bp rate cut overnight; Main takeaways – (1) A 25bp cut and end to balance sheet runoff; (2) Two dissents (George and Rosengren), which is at the upper end of expectations; (3) Insurance cut, no clear hints towards September easing... Chair Powell argues the cut is a ‘mid-cycle adjustment to policy’ though clarifies by saying he is not indicating just one rate cut. (4) US outlook good… Chair Powell portrays the US outlook as benign, with the labor market solid and inflation expected to return to target. (5) But risks remain. Foreign growth has disappointed and foreign central banks are easing, trade tensions remain, inflation is muted and businesses have been somewhat cautious. Despite the noted resilience, the external drags are already having an effect on the US economy. Citi analyst base case - a 50bp total downward adjustment in policy rates this year with one further 25bp cut expected, most likely in September.      

• Market Reaction and FX Outlook –  FOMC meeting overnight is hawkish relative to dovish expectations …pushes up USD while risk assets come under pressure and global yield curves flatten. Tactically, USD could strengthen further near term against “carry” currencies (AUD, NZD, CAD and EM) and euro bloc (EUR and GBP).  But as the “hawkish” FOMC also hits risk appetite during the current low-liquidity holiday season in August, this may favor JPY, CHF and Gold on non USD crosses with Citi analysts maintaining their 3Q’19 average gold price forecast of $1,425.                 

• USTR Lighthizer and Treasury Secretary Mnuchin conclude their trip to Beijing with the next round of trade talks likely to be held in September, according to news sources. Global Times editor in chief Hu Xijin hints at some progress on agriculture, saying “…Chinese and US negotiators had an efficient and constructive deep exchange. The two sides discussed increasing purchase of US farm products and US side agreed to create favorable conditions for it. They will hold future talks.”

• Headline Q2 CPI produces an upside surprise at its strongest in 18 months and pushes yearly headline CPI from 1.3% to 1.6%. Underlying CPI though remains soft with both the trimmed mean and weighted median CPI (underlying CPI) rising 0.4%QoQ, in-line with market expectations and Citi forecasts. Bottom Line – The CPI result argues against another near-term RBA rate cut and may leave the market challenging current dovish pricing (or at least keeping a floor on it). This suggests limits to near term weakness in AUDUSD caused by the “hawkish” FOMC meeting overnight.         

EZ slowing growth momentum; UK PM hints UK may stay in EU single market/ customs union until 2021 in Brexit shift       

• Euro zone data has limited impact overnight ahead of the Fed FOMC but for the record, euro zone Q2 GDP slows to just 0.2%QoQ, in line with expectations though slightly better on a YoY basis at 1.1% while euro zone July CPI slows to 1.1%YoY as expected, but core CPI now sub-1%, at just 0.9%YoY vs 1.1% in June. Forward looking indicators such as European Commission consumer confidence and Markit PMIs suggest growth in Q3 will remain muted, with manufacturing continuing to underperform. This likely affirms the ECB’s dovish stance to introduce an easing package come September, as signaled in last week’s ECB meeting.  

• In what may be the first sign of a possible shift in his position on Brexit, UK PM Johnson hints Britain could remain in the EU customs union and single market for another 2 years after Brexit (Sun reports). This comes during a visit to Wales when the new PM indicates a transition period could be utilized after Britain leaves the European Union on October 31 and potentially marks a small softening in PM Johnson's stance on Brexit. However, GBP continues to be G10’s worst performer as investors continue to price in greater chances of a “No-Deal” Brexit (currently around 40%), leaving the pair down towards 1.2210. Citi analysts’ base case – 35% probability of a “No Deal” Brexit versus 50% chance of a UK general election. Market pricing – a 40% probability of a ‘No Deal” Brexit versus 60% chance of a Brexit extension preceded by a UK general election.                

Stronger Aussie CPI and Canadian May GDP likely to keep both the RBA and BoC on hold in the coming months   

• Solid Canadian May GDP as Q2 activity rebound continues - GDP by Industry in May rises a solid 0.2%MoM, just-above consensus expectations for 0.1% and just-below Citi at 0.3%. But although the 0.23% increase in Canada’s May GDP is slightly-softer than Citi expectation, details of the report are largely unsurprising and the team continues to track a 2.8% (QoQ SAAR) rebound in Q2 GDP by Expenditure. Output in goods-producing industries is strong for the third month in a row, led by manufacturing and construction and the solid May GDP reaffirms an improving domestic activity picture that is likely to keep the BoC in a wait-and-see mode on rates.      

Chinese manufacturing PMI improves, but still below 50           

• China’s official PMI reports for July are a mixed bag with manufacturing PMI rising to 49.7 vs 49.6 consensus forecasts while non-manufacturing PMI declines slightly to 53.7 but remains firm. The manufacturing PMI index is up 0.3pp from June though still in contractionary territory but with all sub-indices except inventories improving, including new export orders and production (up 0.8pp to 52.1). Citi analysts - While its sustainability remains to be seen, China’s broad-based PMI improvement is a good sign for economic stabilization in H2 and believe the government will act more directly on the spending side to boost infra investment. In the meantime, Citi analysts expect monetary policy to be more tilted toward supporting growth with the PBoC likely to lower short-term policy rates and implement interest rate reform. Overall, the PMI data points to the strengthened growth momentum in China and easing industrial deflation risk.         

This is an extract from the Daily Currency Update, dated August 1, 2019. Please approach a Citigold Relationship Manager if you would like more information.