Tariff Man Overshadows Powell’s Tightrope Walking

Havens rallied and the dollar dipped on Friday; but both reversed course as a fresh week began with trade tensions continuing to rattle markets.

Previous Day's Market Highlights

Fed Chair Powell succeeded in walking a delicate tightrope on Friday; carefully striking a balance between nudging open the door to further modest policy easing, while not endorsing the market's current aggressive pricing of around 75bps worth of further rate cuts by year-end. Powell used his keynote speech at the Jackson Hole Symposium to repeat the Fed's pledge to 'act as appropriate' to sustain the economic expansion, a nod towards a 25bps rate cut in September and perhaps one more later this year, while reaffirming that the US economy faces 'significant risks' - largely in the form of a global economic slowdown and the US-China trade war. The dollar reacted relatively well to these comments, which, along with a lack of references to 'insurance' cuts or a 'mid-cycle policy adjustment' resulted in the speech not being explicitly dovish enough to herald the start of an easing cycle. 

However, while markets had been becalmed by Powell's remarks, President Trump was clearly unhappy with both the Fed and with China, the latter having earlier imposed retaliatory tariffs on $75bln worth of US goods. Firstly, having ludicrously debated on Twitter who, out of China's President Xi and Fed Chair Powell, was a bigger enemy of the people, Trump ordered US companies to immediately begin looking for alternatives to China - denting risk appetite. Then, shortly after equity markets had closed for the week, the self-styled Tariff Man went further, announcing retaliatory action, increasing US tariffs on Chinese goods by 5% from October. This latest escalation in the trade war spooked investors, resulting in the dollar selling-off, losing 0.6% against a basket of peers, while the Japanese yen and Swiss franc both benefitted, gaining more than 1% apiece. Bond yields also sank, with the 2s10s spread briefly inverting once again, and remaining inverted on Monday.

Elsewhere on Friday, the pound continued to trade as a barometer of the market's Brexit sentiment, largely shrugging off BoE Governor Carney reiterating that "limited and gradual" interest rate hikes will likely be needed in the event of a smooth Brexit. Sterling ended Friday 0.3% higher against a weaker dollar, and 0.6% lower agains the euro. The common currency benefitted from the dollar's weakness, adding just over 0.5% over the course of the day. Friday's only notable data releases came from Canada, with June's retail sales figures beating expectations. Headline sales were flat on an MoM basis, while sales excluding autos jumped by 0.9% MoM, the fastest pace since March. The upbeat data helped to lift the loonie, despite a slide in oil prices, with the CAD closing 0.2% higher. 

Turning to Monday, markets were volatile despite UK desks being closed for a bank holiday. Trade headlines continued to dominate price action, with markets striking a risk-on tone after President Trump stated that "anything is possible" when asked about delaying the imposition of tariffs on Chinese goods. Meanwhile, survey data continued to paint a bleak picture of the German economy, with the IFO business climate gauge, a well-respected indicator, falling to its lowest level in almost 7 years, before taking into account the most recent developments in the US-China trade war. Whether this is enough to bring about fiscal stimulus in Germany remains doubtful, with many senior officials expressing doubts about the necessity of such a programme.

Away from FX, equity markets were roiled on Friday by the escalation in trade tensions, resulting in the pan-European Stoxx 600 closing 0.6% lower, and the US benchmark S&P 500 shedding more than 2.5%. Risk sentiment reversed course on Monday however, spurred on by Trump's comments on China (above); the pan-European Stoxx 600 closed unchanged, while the US benchmark S&P 500 gained more than 1%. Meanwhile, Friday saw oil prices slide, also as a result of deteriorating US-China relations, with global benchmark Brent losing 1.5%, and US WTI crude settling 2.5% lower. Oil's slide continued on Monday, fuelled by concerns over oversupply, with both Brent and US WTI crude settling around 1% lower.

Today's Market Highlights

A holiday-shortened week here in the UK begins with a relatively light data calendar, featuring little in the way of top-tier releases. Focus for financial markets will likely remain on developments in the trade war, with market participants set to remain glued to President Trump's Twitter feed for signs of further escalation. Meanwhile, sticking with geopolitics, today is the deadline for the formation of a fresh government in Italy. Should parties fail to agree on the makeup of a coalition, President Mattarella will be forced to call elections, which could put the far-right, eurosceptic, Matteo Salvini's party back into power, possibly posing a headwind to the euro in the medium-term.

On the data front, today's highlight will be August's consumer confidence figures from the US, set to show a moderation from July's 8-month high, falling back to a still-healthy level of 129.0. The indicator is an important one for assessing the US economy as an upbeat level of consumer confidence should feed through into a continued solid pace of consumer spending and GDP growth; with economic activity set to be underpinned by strong consumers as business investment slows in the face of growing uncertainties. Other highlights today include US house price figures for June, as well as the Richmond Fed's monthly manufacturing index - though neither will likely be major market movers. The calendar is bare for both the UK and eurozone. A couple of notable central bank speakers are also due, with the BoE's Tenreyro and ECB's de Guindos both set to make remarks. Any comments on future shifts in monetary policy will be closely watched.

Looking ahead to the remainder of the week, the economic calendar remains relatively light. This week's most impactful releases all come on Friday, in the shape of eurozone CPI inflation, US core PCE inflation and Canadian Q2 GDP figures. Markets will keep a keen eye on both sets of inflation figures as aggressive monetary policy easing remains priced in, while Canadian GDP will be examined for any headwinds facing the economy stemming from ongoing trade tensions.