Trade war escalation trepidation weighs

Summary

Imminent escalation of the U.S-China trade conflict has swiftly capped stock market cheer from the ECB’s surprise announcement rates would stay lower for a while longer.

U.S. and Chinese tariffs at the ready

Patches of green remain amongst European bourses. Benchmark bonds are extending, if not matching Thursday’s advance on the back of the ECB’s dual-facing guidance. The dollar faces the latest in a spate of recent reversals against the yen and the VIX anxiety signal flickers in and out of positive territory. Creeping risk reduction follows persistent reports, albeit not official, that U.S President Trump may go ahead with new tariffs on China, perhaps within hours. Other news sources suggest such a move, if coming, may not happen till next week. An announcement on Thursday by China’s top diplomat Wang Yi urging “cooperation and mutual benefit” and warning that China had “also made preparations to respond” added dissonance, as he was speaking with U.S. Secretary of State Mike Pompeo at his side. There are limits on the insurance against a volatile reaction that can justifiably be put on under these circumstances. Even so, European markets with large car-making sectors – see DAX, CAC 40, FTSE MIB –  would see enhanced pressure in the event of deteriorating trade news after warnings that President Donald Trump might impose tariffs to fix supposed unfair advantages. Absent clarification of timing, or indeed probability of new duties, a tint of risk-aversion should stick around throughout the session.

Euro rebound looks futile

The euro’s thunderous tumble continues to echo, dragging EUR/USD to its worst weekly loss for 19 months after terminal damage to the constructive trend from the end of May. It’s difficult to rule-out a retest of the low of that month at $1.1506, but there’s no open and shut case, given undeniable economic improvement. In-line inflation data on Friday backed the recovery scenario, though traders will continue to scrutinise the contribution of energy prices. Buyers initially lifted the spot to dead on $1.16 before trimming a bit, ahead of the data, notching the psychological level as key after the euro regained 40 pips of Thursday’s loss in reaction to the HICP print. An all but inevitable test of Friday’s low – the new two-week nadir – will be an ominous one for buyers.

ECB raises stakes for BoE

Meanwhile, with the ECB’s with moves out of the way, and Japan’s policy decision predictably benign for sterling, the Bank of England is the remaining pivotal central banks still to update policy in the second half of the year. The ECB’s warning that rates may only rise well into 2019 tightens focus on the rate differential to sterling. Thursday’s price action is a precursor of new difficulties the MPC faces as it tries to stabilise inflation, epitomised by this week’s input price rebound whilst CPI came up short. With Downing Street also snatching victory this week, albeit temporary, by defeating rebel amendments to the Brexit Bill, sterling may benefit from the absence of pressure on that front too, ahead of the Brussels Summit on 28^th June. Fundamental conditions could thereby coincide with relative euro weakness to underpin the pound and put BoE policymakers under further pressure.

For now, single currency drama is pulling sterling both ways, with the spot against the dollar dragged lower in the euro’s slipstream, while against the euro, Thursday brought the pound’s best one-day rise this year. As buying interest customarily cycles through sterling pairs, additional support for GBP/USD is feasible. Thursday’s sterling/dollar drag has seen little follow through so far as the pair inches up a handful of pips at $1.3276.  All but the shortest-term trending indicators point lower though, so such upticks face selling pressure, despite daily oscillators approaching oversold.

Tough start, soft end, BoE ahead

Factoring the Bank of Japan’s inflation forecast cut on Friday, which coincided with its governor affirming determination to maintain stimulus, the dollar would be weaker. A flattish dollar here therefore points to the market’s comfort that a widening Fed-BoJ chasm has been adequately priced. This view is unlikely to prevail, particularly if the yen fails to approach Thursday’s USD/JPY 109.89 spike low. Only U.S. industrial production and Canadian manufacturing updates are likely to detain market participants much further on the macroeconomic side after such an action-packed week. Attention is turning to next week’s highlights, with the BoE decision front and centre.