"You can cut the tension with a cricket stump” Murray Walker
Last time we wrote, on the eve of the June FOMC meeting, we discussed our view that the markets were increasingly failing to differentiate between the current US/China trade tension and the slowing in the global industrial cycle or export dynamic - instead choosing to view this as one issue. Furthermore, we went on to highlight our long held view that there will be a rational compromise between the US and China and ultimately a trade resolution that brings lower, not higher global trade tariffs. Despite the rising uncertainties into the G20 meeting at the end of the month - exacerbated by the increased tensions in the Middle East - the meeting between Trump and Xi appears to have put discussions back on track, halted the extension of tariffs and reduced the threat of a more damaging trade war.
However, while the progress at the G-20 was a positive step for global trade and geopolitics, it did nothing (outside of a modest and short lived dip) to arrest the safe haven flow of funds into Treasuries and thus the continued slide of US yields.
It is not just on the issue of trade where there have been significant developments since the last time we posted. The other notable trend of recent weeks has been the further dovish pivot of the Fed and the ECB.
"My Man could have hit that with her broom handle” Geoffrey Boycott
At the June ECB meeting the ECB delivered a series of measures (a six month extension to the forward guidance on rates, a six month extension to the reinvestment of expiring assets under QE and a new, generous TLTRO offering) and highlighted the increased downside risks to the (global and) eurozone economy. However, the initial reaction of the market was one of disappointment. In fact, even when, during the Q&A session of the press conference Draghi (almost certainly intentionally) revealed that the Governing Council had discussed both cutting interest rates further and restarting the QE programme, markets remained underwhelmed and the EUR appreciated modestly.
Next up was Powell and the June FOMC. Despite the fact that the underlying economic momentum and inflation dynamic remains considerably more robust than that of the eurozone, markets have extrapolated fragilities of the global dynamic into explicit expectations of US rate cuts. Current pricing suggests more than 100bps of cuts by the end of 2020. Furthermore, despite the fact that the dovishness of Powell’s speech was veiled and lawyerly, markets were quick to jump on the moderation of the Fed forecasts (the ‘dots’) and US 10 year yields fell below 2.0% for the first time since 2016.
From the perspective of their explicit mandate, the ECB do not target the FX rate. However, it is also clear that the level of the EUR has implications for the relatively open economic area of the eurozone, both for export competitiveness and for the implications for inflation. Furthermore, with monetary policy setting at such extreme levels of accommodation, inflation starting to wane, and a heightened sensitivity to global trade, it is likely that the currency is high up on the ECB’s list of monitored factors. A couple of days after the Dovish Fed (and a further, if modest, rise in the EUR), Mario Draghi was more explicitly and committedly dovish.
From our perspective, even after the central bank ping pong, we see the market as pricing far too much from the Fed, and underestimates the ability of the ECB to act.
In the UK, financial markets have been relatively sidelined as the Conservative leadership process evolves. GBP has been kept on the back foot by the commitment of both candidates to retain the threat, if not the intention of a so called no-deal Brexit. With the announcement of the winner, and thus new PM, not coming until the 24th - just one day before the Summer recess - it is unlikely that GBP is promoted to the forefront of market activity at any time soon. In the meantime, while the sun is out, perhaps we should concentrate on the Cricket.