Enthusiasm curbed for global stocks, as currency wars loom

The positive momentum for stock markets has come off the boil as we enter the middle of the week, with European indices a sea of red, following a weaker performance for US stocks on Tuesday. The reason for the decline is mostly political, US President Donald Trump is threatening higher tariffs for China if a trade deal is not agreed at the G20 meeting at the end of this month, Trump also launched an attack on the weaker euro, and to top it all off Trump lambasted the Federal Reserve for its most recent rate-hiking cycle. 

Will the Fed meet dovish expectations? 

The latter point is worth looking at in more detail. Aside from the fact that the US Federal Reserve is independent and thus should ignore the President’s criticisms of its recent performance, President Trump articulated exactly what financial markets are craving: a rate cut from the Fed. Market expectations for US interest rates have taken a 360 degree shift in recent weeks, a couple of months’ ago the market was looking for up to two rate hikes from the Federal Reserve this year, along came the sharp fall in stocks in May and now there is a 66% chance that the Fed will cut rates at its July meeting, according to the CME Fedwatch tool. 

Why the markets should be cautious about the “Powell Put” 

This number is worth watching carefully. This time next week the Federal Reserve will meet, and we expect to hear more about their intensions for interest rates. Will the bank bow to market pressure and signal a rate cut is on the cards? Or will they be more pragmatic and reinforce their neutral, wait-and-see stance? Major central banks do not like back-tracking on policy decisions, and since the Fed was in rate-hiking mode up until a few months ago, we believe that expectations for a Fed rate cut next month may be premature. At next week’s meeting we expect the Fed to sound sympathetic to the recent downturn in the economic data, including softer inflation,  and to say that it will watch the economic situation closely, however, we doubt that it will give any firm signal to the market that a rate cut is imminent. During his tenure, Fed chair Jay Powell has proven unflappable even in the face of White House pressure to cut rates, we do not believe that he will change his stance now. 

When the Fed chooses not to play ball with the President 

Traders should note that as we lead up to next week’s Fed meeting, the market is likely to start to price in the prospect of a less-dovish than expected Federal Reserve. This is one of the reasons why there has been a broad decline across global markets on Tuesday/ Wednesday. The FTSE 100 was led lower by the financial sector, and also exporters, as the pound rallied. We would highlight that the technical indicators are supportive for the FTSE 100 for now, however, we expect the fundamental factors to dominate as we move towards next week’s Fed meeting. The S&P 500 is likely to open lower, although it may receive a bit of a bounce from the weaker than expected US CPI, which supports a dovish Fed. Overall, we expect US stocks to remain range-bound and choppy ahead of the meeting next Wednesday. 

Trade wars back on the agenda 

Traders will also start to prepare for the G20 meeting in Japan that takes place 28-29TH June. After a fairly quiet few weeks on the US/China trade war front, the rhetoric is heating up again. US President Trump has already threatened much higher tariffs on Chinese goods if a deal isn’t completed. If the tit-for-tat rhetoric starts to ramp up between Washington and Beijing ahead of this meeting, then stocks and other risky assets are likely to struggle to regain the momentum that we saw at the start of this month. 

Why Trump can’t control the euro 

Currency wars may also become a theme as we progress throughout the year. Donald Trump also bemoaned the weak euro on Tuesday; however, it’s had no impact on the performance of the single currency so far, and EUR/USD has fallen an extra 30 points on Wednesday. Unless EUR/USD can get above the 1.1370 level, the 200-day sma, then it is hard to see how the euro can sustain a decent rally. The dollar’s comeback today is impressive since it has come on the back of weaker CPI in the US. The dollar index may embark on a sustained rally if it manages to rise above 96.85-90, the highs from last week.

Trade idea of the week: GBP/USD could benefit from BOE hawks

Compared to other major central banks some Bank of England members have sounded significantly more hawkish than their global counterparts this week. Both Michael Saunders and Andy Haldane, the BOE’s chief economist, have said that a rate rise is possible in the coming months. Haldane said he would like to see a small rate rise to nip any inflationary pressures in the bud, while Saunders dismissed the suggestion that the MPC needs to keep rates on hold until Brexit is all sewn up. Saunders would prefer that the bank returns interest rates to a neutral stance at a faster pace than the market currently projects. The next BOE meeting is on June 30th, and if this sentiment shines through, then we could see a re-pricing of interest rate expectations and a boost for the pound. 

In the short term, these comments are significantly more hawkish than other major central banks, such as the Fed and the ECB. If GBP/USD can rise above 1.2795 – the 38.2% retracement of the early May to late May decline – then we may see a rally in the pound, back towards 1.29/ 1.30, a major psychological level of resistance.