Themes to watch:
Trade wars: oil takes a battering while stocks and FX fairly sanguine
Two key events could determine the direction of the major FX pairs and markets this week. The first is the trade wars between China and the US. The US stuck to its guns and imposed tariffs on $34bn of Chinese goods first thing this morning, China wasted no time in saying it would impose retaliatory tariffs. Already US goods including a cargo of soya beans, have been levied with Chinese tariffs, which has knocked investor mood at the end of the week.
However, at this stage, $50bn of tariffs on Chinese goods (another $16bn will come into effect later) is not enough to de-rail the global economy. Until we know if more are coming down the pipeline, then we believe that the bulk of the bad news is most likely priced in. This may be why stock markets’ reactions so far have been fairly muted, even though markets are trading with a risk-off tone. This leaves markets, once again, sensitive to news flow and President Trump’s proclamations on Twitter.
On the FX side, the yen and the euro seem to be the big winners from the trade war, while the dollar index has slipped back a bit, however the move is small so far, suggesting that the FX market is not willing to move further on the back of trade war rhetoric until the tariffs step up a gear and start to threaten global growth. Likewise, emerging market stocks are edging towards their first gain this week, which is further evidence that the market’s reaction to the trade war theme could be overdone.
However, oil bulls are struggling, with both Brent and WTI declining sharply at the end of last week. This is worth noting, as it suggests that there is some caution in the market. Since oil powers the global trade market, especially in goods, if commodities continue to drop then a broader sell off in risk could be on the cards. At the end of the week, WTI was down more than $2 on the week. A break below $70 for both WTI and Brent could have a psychological impact and trigger further declines.
Pound upside limited:
This could prove to be a pivotal weekend for the pound as we wait to see the outcome of the crucial Brexit talks. Theresa May and her fractured cabinet are desperately trying to come up with a consensus to provide the EU with the UK’s plans for its economic relationship with the currency bloc after March 2019. This is proving no easy task. After years of beating around the bush, May needs to get something down on paper that will tell the world whether we remain in the single market, in the customs union or out altogether.
The Brexiteer camp are showing no mercy to May and are threatening to cause all kinds of trouble if she doesn’t stick to her mantra that Brexit means Brexit. Of course, the fact that half the country didn’t want to leave the EU doesn’t seem to feature on their agenda. Already Boris Johnson and former PM David Cameron have savaged the plans, which suggests this summit could be doomed. Renewed pessimism over the Brexit negotiations is one reason why EUR/GBP has broken higher today and is close to its highest level of the week so far.
If this weekend’s meetings trigger mass Brexiteer resignations, or a credible leadership challenge to Theresa May then we could see the pound take a sharp tumble at the start of this week. A break back towards 0.90 in EUR/GBP can’t be ruled out, while weakness in GBP/USD could take longer to follow through due to trade-related woes for the dollar, however $1.30 in GBP/USD may start to appear likely if we see May’s premiership become increasingly precarious in the coming days.
Data to watch out for this week includes:
UK manufacturing and industrial production – May
Production levels are expected to bounce back strongly adding fuel to the fire that the UK economy roared back to life in Q2. This could be pound positive in the short term.
German ZEW – July
This index is expected to pick up slightly, however, the threat of tariffs on German cars from the US could make a downside surprise slightly more likely and may knock the euro in the very short term.
Bank of Canada rate decision
A rate hike is expected, with markets now pricing in a 70% chance of a hike after the governor sounded concerned about inflation pressures. We expect a rate hike to be mostly priced in at this stage, although the CAD could bounce.
The market will be looking to see the extent of the discussion around removing liquidity and the potential for an earlier than expected rate hike next year. The euro could be sensitive.
US consumer sentiment, July
This is the first reading of July consumer sentiment. Will Trump’s trade wars have knocked sentiment, which has started to level off in the last couple of months? Also, could this add to the recent chorus of US data that has missed expectations? We shall have to see.
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