Sunday 18 August 2019

Daily Market Update: Eur/USD down to near $1.06 as policy maker comments again highlight policy divergence between ECB and Fed

Simon Barry

Eur/USD came close to the $1.06 level in overnight trading in Asia, with downside continuing to be favoured as traders absorb the latest policy signals from both sides of the Atlantic.

In Friday’s commentary we touched on a speech that Draghi was giving as we were writing which was the latest instalment of dovish ECB speak. As we noted on Friday, the key piece of new news for markets in that set of comments was around the possible need to act to get inflation up as quickly as possible. And other elements of the speech underline the President’s dovish view at present, including a remark that measures of core inflation have been “drifting down since mid‐2012”. While it is true that core inflation is currently lower now (1.1%) than it was then (around 1.6%), it has been drifting higher not lower over the past six months, having clearly turned up from what was the cycle low of 0.6% seen in April. So to us it seems like Draghi is very much taking a glass half empty view of inflation developments. To be honest, we continue to be a little surprised at just how determinedly dovish are the ECB President and some of his key colleagues at present given the recent gains in core inflation and signs that the modest cyclical recovery remains on track (the flash October composite PMI has just been released in the past few minutes and recorded a positive surprise in reaching its highest level since May 2011).

It looks increasingly as if their dovish stance is being motivated more by a high‐level assessment that the amount of stimulus currently in the system just won’t be enough to get inflation back to target, rather than a regular “the economy is going off‐course” type argument. In this respect, we think that the coming policy action is in some ways a delayed response to the ECB staff’s own projection in September which showed inflation not getting back to target by end‐2017. In any event, these guys are the ones that set policy and the decidedly dovish signals coming from Draghi & Co. clearly warrant both attention and respect.

In contrast, the head of the San Francisco Fed John Williams has been quoted over the weekend as saying that he sees a "strong case" for raising US interest rates when Federal Reserve policymakers meet next month, as long as U.S. economic data does not disappoint. Williams is seen as a moderate within the FOMC whose views are sometimes taken as a guide to those of Fed Chair Yellen, so his blunt and explicitly hawkish comments serve to highlight both the likelihood of imminent Fed tightening and the contrast between Fed and ECB policy at present. In turn, this now very familiar theme of policy divergence continues to underpin our view that Eur/USD likely faces further downside in the period ahead. In particular, we note that as things stand this morning, the market is assigning about a 70% chance of a 25bps hike by the Fed next month. That continuesto look on the low side to us: we would put the probability at perhaps 80‐85% given the clarity of signal from the Fed of late, even if the outcome is still subject to data uncertainty between now and December 16th. In other words, there is still scope for market expectationsregarding the December outcome to harden further in the next few weeks, thus lending additionalsupport for the dollar on the exchanges.

Turning to the week ahead, the US celebrates Thanksgiving this week, so all data releases will be condensed into Monday‐Wednesday. The Markit PMIs should give a lead in to next week's ISM and the manufacturing PMI will be reported today and is expected to decline slightly from 54.1 to 54.0 for November. The second estimate for Q3 GDP is published tomorrow and is expected to be revised from 1.5% to 2.1% q/q on an annualised rate. The services Markit PMI figure is published on Wednesday and expectations are for the index to tick upwardsfrom 54.8 to 55.1. Subsequently, the composite will also be reported after printing at 55.0 in October. Expectations are for the consumer confidence index to advance tomorrow, from 97.6 in October to 99.5 in November. Following last week’s uptick in core CPI inflation, there will be attention this week on the PCE deflator announcement on Wednesday. Expectations are for headline inflation to increase from 0.2% to 0.3% y/y in October and for core (ex. food & energy) inflation to rise from 1.3% to 1.4% y/y.

The final results of the University of Michigan survey consumer sentiment survey is announced on Wednesday. The index is expected to remain unchanged from the previous estimate of 93.1 for November. Medium term inflation expectations are also published after an initial estimate of 2.5%. Finally, personal spending is expected to increase 0.3% m/m in October after advancing 0.1% in September on Wednesday.

In the UK, Q3 GDP is expected to remain unchanged from the first release at 2.3% y/y. Analysts will get their first look at the breakdown of GDP components and there will be a sharp focus on both private consumption and investment. Bank of England Governor Mark Carney testifies before the UK Treasury Committee tomorrow and it is probable that he will be probed about the monetary policy outlook of the MPC. Chancellor of the Exchequer George Osborne also presents the 2015 Autumn Statement (the annual public finance statement) on Wednesday. Finally, the IFO Business Climate is published tomorrow in Germany and is expected to remain unchanged at 108.2 in November.

Have a good week.

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