Rates as of 06:00 GMT

Market Recap

GBP fell to a new year-to-date low after the BRC sales figures showed a larger-than-expected decline in sales in June. A Bloomberg survey showed economists now expect the UK economy to contract by 0.1% qoq in Q2 (previously they had expected no change) and no longer expect the Bank of England to raise rates this year. And there were more shenanigans about Brexit in Parliament; Parliament voted (by a one-vote majority) that the body should have to meet between September and December, which rules out the possibility of the Prime Minister shutting down Parliament in order to force a no-deal Brexit through by the Oct. 31st deadline. However, Boris Johnson – the cretin who’s the favorite to become the next PM -- refused to rule out suspending Parliament if it's the only way to get the UK out by Oct. 31st. And just to make matters worse, the opposition Labour Party announced its support for a second Brexit referendum on any

Brexit deal. That’s important because any deal will need some support from Labour, since the Conservatives are hopelessly split on the issue. So now it looks like no deal will be able to get a majority anyway. What a mess. GBP negative

Today’s market

A really busy day today!

Today is short-term indicator day in Britain. That’s the day they announce the monthly GDP figures, manufacturing and industrial production, and the trade balance (as well as construction output, which isn’t significant for the FX market).

The GDP is the most important of the three. The mom rate is expected to bounce back after two consecutive months of decline. Still, it’s not expected to bounce back enough to keep the 3m/3m change from decelerating further, confirming that the economy is stalling.

Of course, that should come as no surprise to anyone who tracks the UK PMIs. The composite indicator fell into negative territory in June, indicating that output as a whole is contracting. It would be no surprise if the GDP figures reflected that too – after all, the PMIs were invented to give an early read on the economy as a whole. Nonetheless, confirming this fact from the official figures is likely to be negative for sterling. With the economy likely to grow far less than the Bank of England’s 1.5% forecast, there’s less and less chance of an interest rate hike this year – on the contrary, the rate hiking cycle in Britain may have already peaked. That’s the impression I got from BoE Gov. Carney’s speech last week, which seemed to be preparing the markets for a change in the Monetary Policy Committee’s bias at its meeting next month. 

On the other hand, industrial production and manufacturing production are expected to bounce back strongly after the previous months’ sharp decline. Part of this is a recovery in auto production after several factories shut down in April, plus a small upturn in exports (see next). But that won’t override the concerns that the GDP figures raise. GBP positive, though I don’t expect it to be the determining factor for GBP today.

Britain’s trade deficit is expected to widen somewhat from the previous month, although remain narrower than the recent trend (as shown by the six-month moving average).

This is not however due to any great increase in exports. Rather, there was a huge surge in imports earlier in the year as companies prepared for a “no deal” Brexit. That caused the deficit to balloon. Since then, imports have come down.

Next up is Fed Chair Powell’s twice-yearly testimony to Congress, to the House Financial Services Committee today and the Senate Banking Committee tomorrow. We’ll also get the minutes of the June 19th FOMC meeting. So we should get more clarity on the Fed’s position.

Powell will be testifying on behalf of the FOMC, which means his prepared comments (which should be released at 12:30 GMT) usually reflect the view of the FOMC as a whole – what’s already known from the statement following the meeting, his press conference afterwards, and later today from the minutes themselves. The fun begins with the Q&A, when he can address what’s been happening more recently.

Powell will no doubt be asked what he makes of the falling PMIs, small rise in the unemployment rate, fall in hours worked, slowing growth in earnings, low inflation, even lower inflation expectations and record low bond yields around the world…there’s plenty he could mention as to why the Fed might need to take some action to “sustain the expansion,” as he put it. On the other hand, with nonfarm payrolls still growing at a healthy pace, the unemployment rate still exceptionally low, and PCE inflation steady, perhaps he will stress “patience” again? The Fed doesn’t like to surprise the markets and so three weeks before the FOMC meets again, I would expect him to give a fairly obvious hint about what he thinks is likely to happen.

The most important point, I think, is what he and the Fed think about inflation. That is after all the Fed’s main responsibility. In that respect, what Powell said in his press conference last month is important to bear in mind:  "Wages are rising…but not at a pace that would provide much upward impetus for inflation. Moreover, weaker global growth may continue to hold inflation down around the world…and we are well aware that inflation weakness that persists even in a healthy economy could precipitate a difficult-to-arrest downward drift in longer-run inflation expectations." This is basically the case for cutting rates preemptively even if the economy is healthy. Note that not only are market-based measures of inflation expectations drifting lower, but also the latest U of Michigan survey showed long-term inflation expectations (5-10 years) back at their lowest level ever (2.6%). Watch carefully what he says about inflation expectations. That probably holds the key to the next Fed move.

At the beginning of the year, the market thought rates would almost certainly be either unchanged or higher by the end of the year. Now that’s seen as having zero chance; the question is only how many cuts there will be. Right now a Fed funds rate of 1.75%, i.e. three more cuts, is seen as the most likely scenario. In that case they better get started soon, because there are only four FOMC meetings left this year! But that’s considered only slightly more likely than two more cuts. In short, the market doesn’t really know what to expect. That’s what they’ll be looking for some guidance about.

I expect Powell to hint that they will ease policy at the next meeting. That could be negative for the dollar, even if the market is already 100% expecting it. However, how he expresses it will be crucial. Will he make a case for a series of rate hikes, or one protective “insurance” cut? That’s what people will want to know. I expect he will make the case for only one rate cut – probably of 25 bps -- and will stress that the Fed will be “data dependent” after that. Such comments could dampen speculation about three or more cuts and thereby be positive for the dollarThe market has basically dropped the idea of a 50 bps cut at the July meeting, but there are still questions about the pace of cuts after that.

Finally, the Bank of Canada meets to set rates. This s the only major central bank to meet this week. The market has had a hard time this year trying to figure out what the Bank of Canada would do. Early on people expected them to hike this year, and twice people thought it was likely they’d cut, but now it seems most people are settling on the idea that they’ll be unchanged.

The forward guidance at their last meeting was that “the degree of accommodation being provided by the current policy interest rate remains appropriate.” That was somewhat less dovish – neutral, really – when compared with the previous comment, which said “Governing Council judges that an accommodative policy interest rate continues to be warranted. They said, as most central banks do nowadays, that they would remain “data dependent,” and added that they would be “especially attentive to developments in household spending, oil markets and the global trade environment.” Since then, household spending (as shown by retail sales) have slowed, oil prices have fallen and the global trade environment remains as chaotic as before. So no reason to switch to a tightening bias, that’s for sure. But neither are the declines bad enough to justify returning to a loosening bias, either. In particular, the Canada business outlook survey, which Bank of Canada Gov. Poloz puts            a lot of weight on, has turned up noticeably. The sharp rise in “future sales growth” indicates business confidence in household spending – so no need to change course. I expect a relatively unchanged statement from the Bank of Canada that will have little impact on the currency.

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Marshall Gittler

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