Cavalier Attitudes

Submitted by Michael Every of Rabobank

The combination of surprisingly dovish comments from Fed Chair Powell and the tone of the June FOMC minutes reassured the market about the prospect of some policy stimulus at the end of the month.  In response to questions from Congress men and women, Powell clarified that the stronger than expected US June Labor Report did not shift the Fed’s policy outlook.  Instead he stated that uncertainties about global growth and trade continue to weigh on the outlook. 

From the point of view of investors, up until now the prospect of more cheap money has outweighed both economic and geopolitical risks. On the back of Powell’s remarks yesterday the S&P 500 briefly moved about the 3000 level for the first time, though it closed below. The optimism drawn from the Fed Chair’s remarks seem to wear a little thin towards the end of the European session where stocks closed lower.  While Asian stocks were broadly higher, the strength of the JPY overnight told a more ominous story.  The safe haven JPY is the best performing G10 currency on a 1 day view and USD/JPY is this morning trading back down in the 108.00 area. 

The JPY’s sensitivity to bad news is particularly acute with respect to geopolitics. This morning the UK government issued the statement that “Contrary to international law, three Iranian vessels attempted to impede the passage of a commercial vessel, British Heritage, through the Strait of Hormuz.” After intervention by a British warship, the Iranian vessels backed-off.  On Wednesday Iran President Rouhani warned the UK that it would face unspecified consequences as a result of its seizure of an Iranian oil tanker bound for Syria last week.  He also warned London that “You are an initiator of insecurity and you will understand its repercussions.”

Oil prices had already extended gains yesterday as President Trump vowed to impose more sanctions on Iran in protest at its nuclear ambitions.  A cut in Mexican outputs ahead of a hurricane and news of a drop in US inventories also supported the oil price.  French President Macron is trying to salvage the Iranian nuclear deal but he could find himself on the back foot with Trump for other reasons.  The US President has reportedly instructed officials to investigate France’s plans to tax large technology companies given the suspicion that this is unfairly targeting US companies.  Given the simmering trade tensions between Europe and the US, the results of this investigation will be closely watched. 

GBP/USD managed to pull away from its weakest levels in 2 years yesterday despite a set of mediocre UK economic data. Monthly GDP figures for May managed a better than expected 0.3% 3m/3m.  However, against the backdrop of weak production and construction data and signs that the consumer sector is also softening, the market is aware of the risk that GDP for the second quarter could still contract.  Even more worrying for the market is the risk of a no deal Brexit which has been linked to Boris Johnson – the favorite to win the Tory leadership battle.  According to Ivan Rogers, the UK’s former ambassador to the EU, the markets have until now seriously under-priced the risks of a no deal Brexit while the current political generation is “cavalier” in its attitudes.

The vast majority of EM currencies benefited from Powell dovish message with gains versus the dollar led by the South African rand. To our mind the Turkish lira is the best example to illustrate the powerful impact of rising market enthusiasm that the Fed will be cutting rates. Shortly before Powell started his testimony to Congress, President Erdogan confirmed media reports that Governor Cetinkaya was dismissed as he did not follow “instructions” on interest rates. Presumably Cetinkaya preferred to cut gradually against the will of Erdogan who firmly believes that high interest rates are the main cause of inflation. “You will soon see how interest rate policy will be shaped”, said the influential Turkish president who is charge of monetary policy. It is absolutely crucial to emphasise that if it was not for the prospects of major central banks led by the Fed flooding financial markets with liquidity, USD/TRY would be on its way to yet another all-time high after President Erdogan essentially confirmed that Turkey does not have an independent monetary policy. We seriously doubt that Turkey can get away with such obvious shift towards unorthodox policies. When the external backdrop worsens, USD/TRY is likely to quickly regain its upside momentum if the interest rate differential between Turkey and the US narrows markedly as a result of Governor Uysal following instructions from President Erdogan to cut rates significantly. 

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