It would be remiss not to comment on the ‘events’ that took place in Canberra last week. The AUD did move to the downside over the 3½ days the Liberal Party tore itself apart. However, if we break down the actual move from top to bottom the AUD moved just over 100 pips. Now that is somewhat a significant move however, if we actually look at a 100 pips over a timeframe of 3 days it not all that dramatic. Furthermore the majority of the move into the low end of the 72 cent handle was due to Deputy Governor Guy Dobelle speech last Thursday stating that Australian inflation is actually likely to fall in the final two quarters of 2018, which has further pushed out rate expectations.
Therefore I would argue that although the political situation did create a risk off scenario it was not on the same level as that being created in the US and not to the same extent that economic and monetary policy releases have.
Now, due to the events of last week one may have missed the political tensions in the rest of the world and tensions that actually affect markets.
In the US the final tranche of the original US$50 billion of tariffs on Chinese goods was released ($16 billions of additional tariffs). While across-Atlantic relations went to a new low under this President as he finally delivered the much anticipated tariff hit on European manufacturing, the auto industry.
The US Trade Representative is due to give a further update of the proposed additional US$200 billion of tariffs on Chinese goods this week. Market risk so far has been seen only in Asian equities however, it is beginning to trickle into US exposures. The update is likely to be used as a trade mechanism for the White House having reopened trade talk with China last week. The Chinese are unable to match the proposed US$200 billion so how Beijing engages with the White House on this matter will be of interest. From a currency perspective if the talks stall or fall away the White House is likely to ramp up its protectionism rapidly, therefore expect volatility in Asian markets and further EM currency risk.
As mentioned across-Atlantic relations hit a new low with the President announcing at a rally in West Virginia last week he would propose placing a 25% tariff on all European cars exported to the US. This protectionist policy is unsurprising, the President has been threatening this kind of policy on the EU for 2 years, it plays perfectly to his voter base and ahead of the midterms – it’s a vote buyer.
The market reaction in the STOXX 600 Auto sector was savage falling 7.5% in 3 days and is likely to face more pressure as the President will likely ramp up this rhetoric when the electioneering hits full swing. The reaction in EURUSD as also swift a solid fall back to $1.13 handle. Now this risk off event is clearly White House policy driven, however that is not how the President see it and continues to accuse Brussels of currency manipulation – again playing to his voter base and further EUR risk. I still see downside in the EUR.
The Fed: the USD very much fell out of bed on Friday night as the Federal Reserve Chairman Jay Powell reiterate that rate rises from the Federal Reserve are warranted as the ‘strength’ of the economy is absorbing the current rises and a return to the neutral rate was the longer term goal of the Fed. However the speculated ‘harder and faster’ rate rise expectations had some cold water poured on it after his comments around inflation. The Chairman stated that there were ‘no clear signs’ US inflation was accelerating above 2% – this sent the USD tumbling and had some suggesting the Fed is turning dovish. However, that comment suggests that are no clear signs; now, it is buys the Fed some time and takes some heat of the President has directed at the FOMC. But, there is no denying inflation is coming; when you have employment growth as high as it is coupled with wage inflation and higher levels of consumption it will come. Which is why I am staying the course – the Fed will raise rates 6 times by December 19 and that will mean a stronger USD.