Morning Commentary: Transitory versus Temporary

Foreign Exchange - Morning Commentary
Transitory versus Temporary
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Several central banks meet this week with markets particularly focused on the central banks in the US, UK and Japan. 

Looking specifically at the US, the probability of a rate cut this year has risen from ~20% as of the beginning of the year to roughly 99% as of this morning.  Specifically for this the Fed’s meeting this week, the probability for a rate cut stands around 22%. 

While inflation remains under target and there are signs of a slowing economy--today’s Empire manufacturing print came in at its lowest level since 2016—a rate cut this week does seem premature.  The Fed continues to hold the view that transitory factors are suppressing inflation and as such inflation measures should eventually rise. 

Given this, market conditions have clearly changed since the beginning of the year.  As such, expect the Fed to make some tweaks to its messaging that will likely acknowledge the possibility for a cut later this year.  However expect any change in messaging to be done in such a way that preserves optionality.     

The reason for this optionality, beyond central bankers’ long held preference for flexibility, is the highly uncertain nature of the global trade picture which has the possibility to be either a temporary drag or a sustained headwind. 

With regards to China, the public hearing on President Trump’s proposed tariffs on an additional $300 billion of Chinese goods begins this week.  Additionally, markets continue to expect a meeting between Presidents Trump and Xi at this month’s G20 meeting.  Should there be a de-escalation of trade tensions, similar to what happened at the G20 meeting in Argentina last year, the bar for a Fed cut would likely be raised.  Conversely, further deterioration of trade talks would most likely add additional strain to financial conditions and consumer confidence. 

Of course all of this doesn’t include the possibility of auto tariffs on EU automakers as well as increased tariffs from India on US goods in response to an earlier decision from the US to end its trade concession to India.  All in all, there remains many variables for central bankers to track when it comes to trade.      
HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT:
  • Protests in Hong Kong have prompted officials to suspend proceedings to a law that would have allowed the extradition cases to China.  Focus has now shifted to calls for the complete withdrawal of the bill and the resignation of Carrie Lam, Hong Kong’s Chief Executive.  In an illustration of a difference in opinion, organizers say a record 2 million people, or roughly 1 out of every 7 residents, joined the protest.  Police, which have historically reported conservative numbers, put the number of protesters around 340,000.
  • The US’s Empire manufacturing data for June came in at -8.6 versus expectations for an 11.0 print.  This record drop from the last print of 17.8 also marks the lowest level since 2016.
  • RBA minutes are expected out later today.  Markets will be looking at the minutes for further details around the RBA’s recent dovish pivot. 
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