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USD bounces back as US political risk eases
GBP loses momentum amid political jitters
Sterling went under renewed pressure on Monday morning with Brexit negotiations expected to make a comeback this week. The pound was the worst G10 performer as it slid 0.50% against the greenback with GBP/USD easing as low as 1.2967.
Over the last few days, the pound has been testing the 1.3000-50 resistance area as investors anticipated a strong Tory majority at the upcoming general election. However, their confidence has been damaged recently over Prime Minister Theresa May’s propositions to amend the social care system and revelations that its introduction was kept in the strictest confidence, putting into question the unity of the Conservative party.
Knowing that the GBP has been rallying strongly on anticipation of a stronger Tory majority following the elections, investors are naturally trimming their bullish bets on the pound. GBP/USD has returned below the 1.30 threshold and is heading towards the next support at around 1.29. We remain cautious on the GBP outlook, especially since the tone between the EU and UK has turned up as discussions surrounding the “divorce bill”.
Focus back on US fundamentals
Markets have refocused on fundamentals yet are keeping one eye on the political risks. With US President Donald Trump - the lone source of market volatility - now traveling in the world’s most unstable region, even the most bullish investor is skittish.
On Wednesday (24 May), the FOMC meeting minutes will be released. The primary takeaway is that most members view the slowdown in 1Q as transitory. Members should point to the weak inflation reads as one-off factors and indicate that the strong labour market, including an upwards trend in wages, will pressure prices. In regards to the path of normalisation, we suspect this will remain unchanged with two rate hikes in 2017. While expectations for a June hike sagged slightly after the recent US political noise, we still anticipate a 25bp hike in June (another in September). Fully pricing in of June should see mild USD demand.
Finally, the most critical question is around balance sheet reduction and the lack of consensus (objective & strategy) will sideline any update. We continue to expect the balance sheet reduction strategy to be released in September with a passive and simple strategy that will involve natural roll-off (over forced selling) reducing portfolio to $2.5 trillion.
The thin calendars of Fed speakers pre-blackout in the coming weeks suggests trade will only have economic data on which to adjust June expectations. Elsewhere President Trump has sent a letter to Congress that officially starts a 90-day countdown before the US, Mexico and Canada begin the negotiation process for NAFTA. We believe the end result will be pleasing to free-trading advocates. Yet clearly there will be noise and we would position ourselves to buy CAD and MXN on dips.
Eurozone: Le Maire and Schauble meet today in Berlin
Continuing the European construction is one of the key points of new French President Emmanuel Macron and we should see reforms in that direction.
Today the German and French Finance Ministers Wolfgang Schauble and Bruno Le Maire will meet in Berlin and we know that discussions will be mostly on harmonising corporate tax rates in Europe. This topic promises to be tough. Indeed we recall that a European reform to be accepted needs the approval of all the 28 members according to Article 48 of the Treaty on European Union.
In Ireland for example, their fiscal is very attractive and the country has clearly an unfair advantage regarding other countries so it is obvious that the country will never give up an advantage so easily. In Greece, would we imagine the country to lower their corporate rate which is one of the highest in Europe (29%) given we know the difficult situation they are in.