Safe Havens back with a vengeance on FOMC “disappointment” and Trump’s tariffs on China; BoE warns of weaker pound in “No Deal” Brexit

Safe Havens back with a vengeance on FOMC “disappointment” and Trump’s tariffs on China; BoE warns of weaker pound in “No Deal” Brexit     

• As markets try to stabilize from this week’s Fed FOMC “disappointment” President Trump overnight, adds further fuel to the fire by imposing a 10% tariff on the remaining USD300bn of Chinese imports, starting from September 1, highlighting a lack of purchases of US agricultural products and reduction in Fentanyl exports as reasons to add on to existing tariffs. Trump says President Xi “isn’t moving fast enough” and warns the new tariffs can be raised to 25% or beyond, though still expects the Chinese delegation to arrive in early September for talks in Washington. Markets await tonight’s US July jobs report (Citi - 165k+ for NFP, an unemployment rate decline of one-tenth to 3.6%, and average hourly earnings to remain at 0.2%MoM). However, the data may have already been overtaken by last night’s Trump announcement of additional tariffs on Chinese goods – now the likely key driver of sentiment in the weeks ahead.        

• Risk sentiment takes a big hit from the Trump announcement on China, with the S&P tumbling from +0.90% to close -0.90%, US 10y yields falling to as low as 1.87/90 and the UST curve continuing to flatten (2s10s fluttering below 15bp), safe havens up with Gold at 1446, JPY outperforming globally (+1.3%) followed by CHF (+0.35%) and EM and commodity currencies taking a pounding (USDCNH up from the 6.90 area towards 6.92 while AUDUSD trades just ~60pips above the YTD low at 0.6741 before rebounding to above 0.6800). Meanwhile, Fed rate pricing jumps from -17.7bp of easing priced for September prior to the Trump announcement to now -21bp and -45bp for December.                   

• BoE board meeting key highlights – (1) No policy or guidance change as expected; (2) Says that even if disorderly Brexit risk is stripped out of current market prices, a “more consistent” forecast would still have somewhat lower paths for GDP growth and CPI inflation in a smooth Brexit; (3) Bank guides to gradual but limited rate hikes – MPC simulates forecasts based on implied Bank Rate at 85bp and 110bp in 2022. In the first scenario, inflation rises above target, in the latter its stays below and suggests that in a smooth Brexit scenario, the Bank would still be hiking, but maybe only once in three years; (4) In a no-deal scenario, many policy makers indicate that rate cuts would be more likely, at least in the short-term. Citi analysts would expect Bank Rate to fall towards 0% and a new QE program; (5) Governor Carney indicates that only 1 in 5 firms are fully ready for a “No Deal” Brexit; Says a “No Deal” means a weaker pound and slower growth. 

Pressure for ECB stimulus in September continues to rise; How far can the pound fall?        

• Pressure for euro zone policy action continues to rise as euro zone GDP growth falls below potential and surveys point to additional softness with the final euro zone manufacturing PMI report  released overnight a sobering read. While the numbers are largely unchanged (euro zone PMI at 46.5 vs 46.4 prior, French PMI revised into contraction territory at 49.7), details confirm that euro zone manufacturing is still deteriorating caused in particular by a sharp fall in new orders. Citi analysts - Unless a rebound materializes soon, weakness in the euro zone manufacturing sector will likely begin to impact confidence in services. Citi analysts especially note that the entry point for EA manufacturing PMI for 3Q-19 is lower than both the 2Q-19 and 1Q-19 averages, pointing to some risk of further deceleration in economic activity at the start of the second half.    

• Assuming the 1.27 – 28 area is the “neutral zone in GBPUSD – anything above sees markets pricing in an orderly Brexit whereas anything below sees markets pricing either (1) a “No Deal” Brexit or (2) general elections in the UK and the prospect of a Corbyn – led Labor government.

• Citi analysts derive from their current probability weighted rates pricing a 40% chance of a “No Deal” currently discounted against a 60% chance of UK elections (and a possible extension to Article 50). Translating this to the move in GBPUSD would be the equivalent of a reversal from 1.2750 in GBPUSD (taking the mid from the 1.27 -28 neutral level) to 1.2200 (a 550pip move) seen earlier this week (when the team conducted its analysis).

• Therefore fully (100%) pricing a “No Deal” would suggest a further 8 big figure fall in GBPUSD to the 1.1400 area whereas fully discounting the prospect of a UK general election and a Brexit extension would likely imply a near 350 pip move lower to the 1.1800 area (ie. near the 1.1841 level seen post the Brexit referendum mid 2016).      

NZD hit by the double whammy of weaker business confidence and the negative global risk aversion backdrop   

• Much weaker ANZ Business Confidence data for NZ this morning (-5.1%MoM versus +2.8% prior) comes against a fragile risk backdrop following the Fed FOMC “disappointment” plus the overnight escalation in US – China trade tensions. This is likely to see further near term weakness against USD and the safe havens (JPY, CHF and Gold). 

Weaker on FOMC “disappointment” and US – China trade escalation           

• Two dissentions and a “hawkish” Powell presser this week has fired up USD against EM with President Trump’s tariff announcement overnight adding fuel to the fire. As a result, markets are turning more negative on EMFX, at least for the short term, as it usually follows through on such bearish events. Indeed, USDCNH spikes from the 6.90 area towards 6.92 following the overnight tariff announcement but has settled back to the 6.90 area for now.            

This is an extract from the Daily Currency Update, dated August 2, 2019. Please approach a Citigold Relationship Manager if you would like more information.