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July was more about politics than economics and markets. When Brussels was choosing its future top bureaucrats or UK was in search for its new leader, market participants were not enthusiastic. They did not really care about protests in Hong Kong or Trump’s efforts to verbally push FED to start cutting interest rates. Equity indices were slowly registering new maximums, being certain that Powell was going to give what markets wanted, trade conflicts were to be resolved and earnings season would bring positive surprises.
ECB learned that Christine Lagarde was appointed as a new chair. She will take over from Mario Draghi in November. Lagarde was one of the most dovish options between potential candidates and had previously been vocal in her support for Draghi’s accommodative stance on monetary policy. She was probably happy with the results of ECB’s July meeting, which sent strong signals to the market that an additional stimulus package would be coming, with interest rate cuts and new rounds of asset purchases both being considered.
Across the Channel, Boris Johnson became the new PM after his victory in the Conservative party leadership contest with roughly two-thirds of the votes going his way. Markets showed their skepticism regarding the potential for the UK to leave the European Union with a meaningful deal, sending the pound to its two-year lows. Still, current configuration of the parliament has regularly demonstrated that it is not willing to allow the Kingdom to leave the EU without a deal and a “no-deal Brexit” therefore is still not the base-case scenario unless general elections or new referendum was to provide a mandate for it. However, the currency market might suggest quite the opposite. EUR/GBP pair was locked in sideways correction since the 2016 and the whole setup called for an eventual move higher (which it did). Now we have a sizeable risk for a pair to test 0.9800 level and eventually go well above parity.
Still, the market was waiting for only one thing in July – results of the FOMC meeting on the last day of the month. Although everything started smoothly (the rate was cut by 25bp and the language of the statement was largely supportive of further possible rate decreases), Powell decided to shock the markets in the end of the press conference, citing “mid-cycle adjustment” as the reason for the rate cut and suggesting no need to start the new longer-term rate cut cycle. As this contradicted with market expectations, we saw a heavy trading and risky assets losing their ground, with S&P falling 1.8% within an hour. Trump was unforgiving in his tweets but there was more to come from Mr. President the next day. On the 1st of August Donald Trump announced 10% tariffs on additional 300 bln of Chinese goods what brought new waves of selling.
We must remind the reader that this is happening on the backdrop of the US economy showing tentative signs of improvement, with the labor market bouncing back from an especially weak print in June and second-quarter GDP growing at 2.1% q/q (beating analyst expectations). Manufacturing remains a weak spot, with July PMI data suggesting that this part of the US economy is on the cusp of moving into contractionary territory. US earnings season is now in full swing and companies look set to deliver low single-digit earnings growth for the second quarter. We doubt that without any positive verbal interference from either FED or the White House (or both) markets will be able to get back to July highs.
As FED cracked under Trump and market pressure, 2-year UST yields could not move back above 2% mark and now, it appears, we will have a probable trading range of 1.50 – 2.00%. Dollar itself continued to be a nightmare. EUR/USD pair “felt bullish” last month but failed to deliver and crashed all the way down to 1.1035. Once again, now 1.0850 mark is exposed though nothing is granted as we watch 1.1200 as a downside bias for the pair. A move above 1.1200 will bring market back to neutral/bullish stance.
With central banks globally playing their dovish games (for example, apart from FED, Korean, Indonesian, Turkish and South African central banks cut their rates in July), high yield and emerging market bonds will have their share of support. In US, an additional USD 181 bln in new issues was added to the HY segment in July (growth of 35% when compared to last year). This appetite as well as narrowing spreads look logical when we take into account that circa USD 14 trln worth of debt is yielding less than 0%.
Gold did not do much over the last 4-5 weeks but it managed to hold on to its gains and these are good news for the bulls. Strong support is now around 1350 level and as we mentioned last month – 1260 is critical for the metal as it keeps keep bullish case alive. Silver looked cheap in comparison to gold and we finally saw quite a rally in it. XAG/USD produced “higher low / higher high” sequence, which is the first building block for a bull run, and now is trading above 17 dollars per ounce. At the moment, we are cautiously looking for the XAG/USD levels closer to 19 later this year. If we see silver falling back below 15 then one will need to rethink his investment.
August, it appears, might bring back some uncomfortable moments to many of the market participants. With Powell dancing around the economic data and pressure from both market and Trump, while still trying to show some independence and dignity, we must ready ourselves for some turbulence and verbal battles. Short-term sell signals have been triggered, so do not be surprised when you see red screens on your trading platforms or hear nervous voices from your favorite financial news portals.