Wednesday, October 16, 2019

Brexit looking increasingly possible; will the ECB lower rates again?

  • Dollar
  • Gold
  • Euro
  • Pound
  • Stocks

Market recap: Rising optimism pushes global equities
US equities rallied on Tuesday, as corporate earnings season got off to a positive start. JPMorgan, Citigroup, UnitedHealth Group and Johnson & Johnson all released better-than-expected numbers, surging 3.01%, 1.40%, 8.16% and 1.62% respectively. Optimism regarding Brexit also contributed to gains, as EU and UK officials involved in negotiations signalled that recent discussions have been productive and that a deal may be close. The DJIA gained 0.89%, the S&P 500 surged 1.00% and the Nasdaq spiked 1.24%.

Safe haven assets though retreated after the news, with gold losing 0.82% and the Dollar Index falling 0.17%. The yen also weakened against the greenback by 0.42%. US Treasuries yields continued their gains, with two-year yields rising 3bps to 1.62% and 30-year yields rising to 2.23%.

Sterling surged thanks to the increased possibility of a Brexit deal, gaining 1.42% on the day and reaching a five-month high of 1.2787.

Stocks also rallied in Asian markets. The Nikkei looks set to continue rising for the forth session in a row, opening 1.23% higher on Wednesday. The Hang Seng Index and the Straits Times Index advanced 0.19% and 0.48% respectively.
Today, investors will focus on Brexit negotiations, as well as earnings reports from the Bank of America and Netflix.

Today’s analysis: ECB to face fresh challenges from new US tariffs
The European Central Bank (ECB) is set to discuss monetary policy on October 24th. This will be Mario Draghi’s final meeting as president before his successor, Christine Lagarde, formally takes his place on November 1st. We will likely see more discussions on the outlook of the EU economy from the ECB, as the World Trade Organisation (WTO) has awarded the US the right to introduce tariffs worth US$7.5bn on European imports (resulting from the dispute between the US and Airbus on illegal subsidies from the EU), which are set to come into effect on Friday, October 18th. Below is a brief list of some of the European imports the US will be placing tariffs on.

*Source: ADSS, United States Trade Representative (USTR)

As the US is the EU’s largest trading partner (the US contributed to 17.2% of total trade in the EU in 2018), a drop in US demand for EU goods may possibly trigger a further drop in employment and the Purchasing Manager Index (PMI) for the manufacturing sector in the EU.

*Source: ADSS, European Commission

While the EU cannot retaliate immediately on tariffs, it is expected to wait for a similar WTO decision on Airbus rival Boeing. EU officials have made it clear they would prefer some sort of settlement but will be ready to apply tariffs in the event that there is none.

*Source: ADSS

As tariffs take effect, ECB members may give more dovish signals on monetary policy at the next meeting. But as the minutes from previous meetings have indicated, there is a strong divide between ECB board members, so changes to the current monetary policy are unlikely.

Currently, EUR/USD has risen due to reduced global risk (a result of easing tensions between US and China officials regarding the trade dispute and the increased likelihood of a Brexit deal). But we expect more potential downside from the euro as we approach the next monetary meeting in October. Hence, the euro is likely to trend downwards as tariffs commence, moving towards 1.098’s level to range between 1.098 and 1.096, representing a downside potential of roughly 0.40%.

*Source:ADSS, Tradingview

The short-term trend for EUR/USD looks to be bullish and the bulls are expected to keep charging forward. But expect them to lose steam as US tariffs on European goods are introduced, putting more downward pressure on the European economy. The euro will likely weaken against the dollar, breaking the support level of 1.101 to trend downward to 1.098’s level.