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FX

President Trump’s objective of weakening USD unlikely to succeed by Fed rate cuts alone

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President Trump’s objective of weakening USD unlikely to succeed by Fed rate cuts alone   

  • Fed speak rails against President Trump’s comments for the Fed to cut a further 100bp and entertain QE (1) Philadelphia Fed’s Patrick Harker - "I do not see more cuts in the foreseeable future. I’d like to stay where we are, which I believe is around the neutral rate for the economy, and see how a lot of these uncertainties and issues resolve themselves over the coming months before we’d make any other move; (2) San Francisco Fed President Daly - Says her support for a cut in July does not reflect concern about an impending recession. The labor market is strong and consumer spending is healthy; (3) Fed President Rosengren (dissenter at the July meeting) - Fed has to be careful not to ease too much when there are not significant problems. The Fed should not focus on USD or world economy. Think the US in a “pretty good place” and is concerned about “costs of easing” such as intertemporal substitution by consumers.                
  • President Trump hints at fiscal measures: 2 options – (1) Proposals to reduce capital-gains taxes by indexing them to inflation. When asked about need for Congressional approval, he replies: “I can do it directly”; (2) Mentions thinking about a payroll-tax cut but notes nothing is imminent though says he will update us “in sooner than a week” about a potential package. He is looking at “various options.”
  • The USD Index (DXY) trades softer in NY overnight as technical indicators flip to neutral. President Trump wants to weaken USD by pressuring the Fed to aggressively cut rates and revisit QE. But his efforts are unlikely to succeed as - (1) the Fed does not appear to be on board with his view – Fed Chair Powell’s speech at Jackson Hole on Friday is therefore the key to watch, and (2) other central banks are easing and the impact of any Fed rate cuts is likely to be muted at best. The only likely effective path towards weakening USD appears to be to conclude a trade deal with China – a successful resolution would likely see RMB reverse its recent weakness with other currencies (EM, commodity bloc and EUR) to follow. Trump’s recent (small but significant) overtures to China may suggest he is steadily coming to a similar view.       
  • Markets await Fed Chair Powell’s speech on Friday at the Fed’s annual Jackson Hole economic symposium. Ahead of that come the Minutes from the July FOMC meeting tonight though secondary to the Jackson Hole speech on Friday.   

 

Italy - PM Conte resigns, three options open; GBP higher on German Chancellor Merkel comments     

  • PM Conte’s resignation paves the way for new consultations by President Mattarella as early as tonight. The outcome of these consultations remains highly uncertain but gives rise to 3 possible outcomes - (1) a continuation of the current M5S-Lega majority, after a reshuffle – least likely, (2) a new government backed by M5S and PD (and small left-wing party LEU) – highly possible and the most friendly EUR option, or (3) snap elections that would probably see the right wing Lega headed by deputy PM Salvini win – least EUR friendly.          
  • But the bigger play for EUR in the short term is the ECB meeting in September- There are 16bps priced for the September 12 ECB meeting while Citi analysts expect a 10bps cut with a resumption of QE. In all past episodes of ECB easing, EUR has tended to weaken in response but this has been because of over delivery by the ECB. This time though, Citi analysts expect a lower rate cut (10bp) from the ECB than markets currently discount (20bp). A lower than market consensus ECB rate cut coupled with a potentially qualitatively different QE program to ECB’s QE1 (emphasis on buying credits rather than just sovereign bonds) together with a powerful German fiscal stimulus possibly later in the year (following the German finance minister’s comments earlier this week) would likely be EUR positive as it serves to boost inflation and growth expectations in the euro zone and lift Bund yields.   
  • On Brexit, PM Johnson’s letter to EC President Tusk overnight, outlining there is no path forward unless the Irish “backstop” is removed, is predictably rebuffed. Paths forward appear to be narrowing though there appears to be a sliver of hope following German Chancellor Merkel’s comments overnight that “we will think about practical Brexit solutions” and there is “no need to reopen Brexit deal for such practical solutions”. Merkel’s comments see Cable rebounding back to the 1.2160 level while Gilt yields also pop 2bps higher to 0.4384%.         
  • Much now depends on PM Johnson’s talks with French President Macron and German Chancellor Merkel at the G7 summit this week but the economic stakes are clearly very high for both the UK and EU – for the UK as shown by the government’s own “Operation Yellowhammer” leaks and the Bundesbank assessment this week on the potential damage to German manufacturing and exports (especially automobiles) on a hard Brexit. Should the G7 talks fail, then it’s “up to “Remainers” to stop No Deal via legislating for an A50 extension or bringing down the Johnson government with a “No Confidence” vote when parliament resumes on September 3.  

           

RBA Minutes - willingness to cut further now evidenced based         

  • The key point from the RBA minutes released yesterday is that “members would consider a further easing of monetary policy if the accumulation of additional evidence suggests this was needed to support sustainable growth” in light of domestic and global economic developments. As a reminder, Citi analysts have updated their RBA call, reducing the terminal cash rate forecast from 0.75 to 0.50% with the final cut expected to take place in February 2020.     

 

This is an extract from the Daily Currency Update, dated August 21, 2019. Please approach a Citigold Relationship Manager if you would like more information.

 

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