Thursday, January 16, 2020

US-China phase one deal signed, will Trump focus on the EU now?

Tags
  • China
  • Euro
  • Pound
  • European Central Bank
  • Bank of England

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Analysts’ Pick: US-China phase one deal signed, will Trump focus on the EU now?

  • Euro likely to remain little changed as ECB’s December meeting minutes will probably only confirm hold in policy for 2020
  • Although unlikely, the euro will face downside risk if ECB’s framework review strays from core concerns
  • Sterling to face pressure as BoE may be considering rate cut
  • US may shift focus to trade relations with EU after signing phase one trade deal with China

ECB's December monetary policy meeting minutes likely to confirm expectations of unchanged policy. Today's focus will be on details of Christine Lagarde's first monetary policy meeting as president. It is likely that the meeting minutes will confirm to investors that it is unlikely for the ECB to make any changes to monetary policy this year and will allow its quantitative easing program (that started at a monthly pace of 20bn euros since November 2019) to continue through 2020 and instead will focus on the upcoming review. During her press conference, Lagarde was cautiously optimistic of the EU's economic outlook although she did mention downside risks to economic forecasts. The meeting minutes are likely to support this as well since the changes in forecasts are mostly minimal, having little effect on the euro as this will likely already be priced into the market.

ECB’s December economic outlook is in line with Lagarde’s press conference statements

 

2020

2021

2022

 

Initial

Revised

Initial

Revised

Initial

Revised

Inflation

1.0%

1.1%

1.3%

1.4%

1.6%

1.6%

GDP

1.2%

1.1%

1.4%

1.4%

1.4%

1.4%

*Source: ECB

Euro will likely rise if the meeting minutes hints at heavier emphasis on factors outside of monetary policy. The other area that investors will focus on is hints of what the monetary policy framework review will encompass. From a broader perspective, the ECB will review its objective and monetary tools. But markets will be looking for hints for what the review will mean for future policy. Lagarde has also stressed that she would like the review to touch on other topics including technological change, inequality and climate change. If the review hints that these factors are likely to be included in the review, markets will likely price in a risk premium as these factors may remove focus on the ECB's primary objective, which is price stability.

The newly signed US-China phase one trade deal may put pressure on the euro. With the phase one deal signed with China, US President Donald Trump may shift his focus to EU. EU Trade Chief Phil Hogan is currently in the US to negotiate with US officials a trade deal. But a trade truce or deal between the US and the EU looks unlikely in the short-term. Trump is likely to shift his focus back to the EU to pressure them into a trade deal, similar to what happened with China. Furthermore, with the latest plan from the US to put tariffs on US$2.4bn worth of French goods, in retaliation against a digital services tax in France that affects American tech giants such as Google, Apple and Amazon, a three-day trade meeting is unlikely to show progress. It is more likely that the EU will be pressured into retaliatory actions against the US, likely in the form of more tariffs. This will weigh on the EU’s economy more and will likely drive the euro down.

Timeline of US and EU retaliatory tariffs since 2018

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Sterling is likely to continue to be weighed down as investors price in higher probabilities for a rate cut. The British pound has declined since the start of the week thanks to weak economic data in the UK. Manufacturing and industrial production for November both suffered a bigger-than-expected decline. The UK's inflation is also starting to show weakness, putting pressure on the BoE to find ways to stimulate the economy. Implied probabilities for the BoE to cut rates skyrocketed since January 8th after dovish comments from BoE Governor Mark Carney and other BoE officials suggested that a rate cut may happen later this month.

BoE sends dovish comments to investors after economic data indicates drag on UK economy

Indicators

Actual

Consensus

Prior

Markit Manufacturing PMI (Dec)

47.5

47.6

47.4

Industrial Production MoM (Nov)

-1.2%

0.0%

0.1%

Industrial Production YoY (Nov)

-1.6%

-1.3%

-1.3%

Manufacturing Production MoM (Nov)

-1.7%

-0.2%

0.2%

Manufacturing Production YoY (Nov)

-2.0%

-1.6%

-1.2%

Inflation Rate (CPI) (YoY) (Dec)

1.3%

1.5%

1.5%

Core Inflation Rate (Core CPI) (YoY) (Dec)

1.4%

1.7%

1.7%

*Source: Bloomberg

Overnight Index Swaps implied probabilities for a rate cut skyrocketed to 66.5% from 5.1% since Jan 8

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We expect the EUR/GBP cross currency to be little changed on the result of the ECB's December meeting minutes, with a low level of downside risk of roughly 0.25% if the minutes hints at the framework review having any emphasis on technological change, inequality or climate change. Then reports on the EU negotiations are likely to be released over the next few days. The euro is likely to face downward pressure since a trade deal is unlikely to happen between the EU and the US during the three days of talks, possibly pushing EUR/GBP down towards 0.8522’s level. In the medium-term, EUR/GBP looks likely to rise as the EU economy seems to be bottoming out and as the outlook for sterling will likely be skewed towards the downside thanks to dovish comments from the BoE.

 

Scenario

Effect on EUR/GBP in the short term

1

ECB meeting minutes confirms hold on policy for 2020; Hogan leaves US with no news of trade deal

Falls past 0.8542 towards 0.8522

2

ECB meeting minutes confirms hold on policy for 2020; Hogan leaves US optimistic of EU-US relations

Rises to 0.8582’s level

3

ECB meeting minutes confirms hold on policy for 2020 but hints at framework review emphasis on non-core factors; Hogan leaves US with no news of trade deal

Falls to 0.8504’s level

*Source: ADSS

Technical Analysis:         

EUR/GBP

Bulls control the euro-pound cross as prices trade above the 50-day and 100-day moving averages. But the bears look to be gaining momentum as prices just fell below the 20-day moving average. Bears will try to retest the initial support at 0.8542 while the bulls look to break the resistance level of 0.8582 in order to retest the 38.2% Fibonacci retracement level of 0.8608. If the bulls manage to break the 38.2% resistance level, it will be a new two-month high for the cross-currency pair and will likely maintain its momentum and trade towards 0.8642’s level. But if today’s meeting minutes goes in favour of the bears and US-EU trade relations continue to sour, then expect the bears to pull EUR/GBP past 0.8542’s level and try to retest the 23.6% Fibonacci retracement level of 0.8485.

Support: 0.8542 / 0.8522 / 0.8504

Resistance: 0.8582 / 0.8608 / 0.8642

EUR/GBP Chart (H4)

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