Submitted by Michael Every of Rabobank
The markets stabilised very quickly after the UK insisted on using diplomatic tools to solve the crisis with Iran, which seized a British oil tanker in the Strait of Hormuz last week. The UK will seek to put together a European-led naval mission to ensure safe shipping through the Strait of Hormuz. Britain is be hoping that various countries will show far more solidarity than the US whose Secretary of State Pompeo said that the UK must take responsibility for their own ships.
With the UK unlikely to pursue military confrontation with Iran, European equities eked out marginal gains and the S&P 500 ended Monday’s session 0.28% higher. That said, relationship between Iran and the West, the US particularly, remains strained. President Trump posted an inflammatory tweet claiming that the Iranian economy “is dead and will get much worse. Iran is a total mess!”
Initially Brent crude extended Friday’s gains, but the bullish momentum faded quickly and prices were not even able to revisit the July 18 high of USD 64.46 per barrel let alone the mid-July top of around USD 67.
EUR/USD continues to lean towards the June low at 1.1181 ahead of the upcoming ECB meeting on Thursday. Apart from market expectations that President Draghi will set the stage for a rate cut in September weighing on the euro, the dollar received a boost from President Trump and congressional leaders who reached an agreement to suspend the US debt ceiling for two years and allow hundreds of billions of dollars in new spending. Speaker of the House Pelosi revealed that avoiding a stock market collapse and a government shutdown were the main factors that played a critical role.
We are in a blackout period for Fed speakers ahead of next week’s crucial policy meeting, but it does not mean that President Trump will refrain from commenting on monetary policy. “It is far more costly for the Federal Reserve to cut deeper if the economy actually does, in the future, turn down! Very inexpensive, in fact productive, to move now. The Fed raised & tightened far too much & too fast. In other words, they missed it (Big!). Don’t miss it again!”, Trump tweeted on Monday.
It is reasonable to assume that Trump would prefer an insurance cut of at least 50bps on July 31 to prolong economic expansion and more importantly for him - given that he sees the S&P 500 Index as a barometer for his presidency – to sustain the bullish trend in US stocks. A 25bps cut may not prove sufficient for Trump, who will express his disappointment instantly on Twitter probably wishing that he could dismiss Powell as easily as Turkish President Erdogan fired Governor Cetinkaya for not following “instructions on rates”. Newly appointed Governor Uysal is set to cut interest rates much faster than his predecessor starting with a few hundred bps move this Thursday. Admittedly, the Turkish lira has been coping surprisingly well with President Erdogan essentially taking control of monetary policy. However, when the external backdrop worsens markedly, the lira will be far more exposed and vulnerable as a result of the CBRT potentially lowering interest rates to levels seen by foreign investors as inadequate to compensate for domestic risk factors.
Day Ahead
The Conservative Party will announce its new leader who will become the new Prime Minister. Hard Brexiteer Johnson is favourite to take over from PM May. However, the parliamentary arithmetic has changed and he will struggle to deliver his “do or die” pledge to leave the EU on October 31. Based on comments from prominent EU officials, it is very unlikely that he will be able to secure a much better deal with the EU than his predecessor whose Withdrawal Agreement was rejected on three occasions by parliament. Johnson’s ultimate solution would be a hard Brexit and he may even consider suspending parliament. That said, MPs passed an amendment to a Northern Ireland bill that prevents the new Prime Minister from requesting a suspension of parliament between October 9 and December 18. Essentially, political uncertainty will not diminish and will continue to weigh on sterling in the coming months.
It is worth noting that speculators increased their bearish bets against GBP to the highest level so far this year, almost matching the August 2018 high. This reflects increasingly negative sentiment towards sterling, which has been the worst performing G10 currency versus the dollar since May.
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