Market expects an ultra-dovish message from ECB

Following yesterday’s weaker than expected Purchasing Managers Indices from both major individual Eurozone nations as well as the entire region, the scene is set for the ECB to do whatever it can to provide more accommodation and greater stimulus to the region’s economy.

Manufacturing output in France fell from 51.9 in June to 50 in July. In Germany, the outlook is even worse. The market had been considering that the worst of the downturn may be over, but yesterday’s data showed that there is still room to the downside. Manufacturing output fell from 45 in June, to 43.1 in July. If repeated next month this could signal a recession in the Eurozone.

For the entire region manufacturing output fell from 47.6 to 46.4. Even services data was a little weaker although it still showed overall expansion, despite a fall from 53.6 to 53.3.

The ECB Governing Council will meet later this morning and while there is very little new accommodation that can be added, Mario Draghi will need to show optimism that the economy is at least bottoming out. Some acknowledgment that the issue is systemic could be seen with a combination of a lack of fiscal tools and the bad debt overhang affecting the banks.

The euro managed to cling on above two-year lows around 1.1106 but if there is no positivity from the ECB an attack on that level is probable.

Yesterday, it reached a low of 1.1127, closing at 1.1140.

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Johnson clears the decks

Fifteen Cabinet Ministers, that is close to half the front bench, either resigned or were sacked yesterday as Boris Johnson took over from Theresa May as Prime Minister.

In an exceptionally positive speech on the steps of his new Residence, Johnson did what he does best and promised changes. Gone will be the cowering under the influence of Brussels, replaced by a new positive country looking to take its place in the world.

It was interesting to note that the tax cuts promised during his leadership campaign were gone replaced by promises of more money for policing, hospitals and social care.

It remains to be seen how these new pledges will be funded but the overall message was that the UK will be leaving the EU on 31st October come what may.

Johnson cannot understand Brussels intransigence about negotiations over Brexit. EU negotiators insist they have finished even though it would be impossible for the current Withdrawal Agreement to pass through Parliament.

The new Cabinet will be made up of those who favour leaving the EU and there have been some big-name departures. Philip Hammond, the Chancellor of the Exchequer, resigned as he said he would, to be replaced by one-time Leadership Candidate Sajid Javid. Johnson’s opponent in the final runoff, Jeremy Hunt, has also resigned commenting that it was time to be a “father to his children”.

Priti Patel will replace Javid as Home Secretary while one-time Brexit Secretary, Dominic Raab, replaces Hunt as Foreign Secretary.

There are significant challenges facing the new Prime Minister other than Brexit itself. Business investment is very weak as companies are worried about committing to re-tooling or employing staff until there is some certainty. The City has concerns about the future relationship and the man in the street is worried about the numbers of jobs that could be lost in a no-deal scenario.

The pound’s reaction to yesterday’s events was muted. It recovered a little versus a weaker euro which was hardly surprising given the Eurozone data. It made a high of 1.1228, closing a little lower at 1.1206. Versus the dollar, it rallied to 1.2522 but fell back to close at 1.2483.

Market now expects a slightly more hawkish Fed

It has been difficult so far this month to keep tabs on just what traders expect from the FOMC when it meets in a week’s time. We have seen a stronger than expected employment report and subsequent data which has not really justified a single cut, let alone a series of cuts which were the base view just a few weeks ago.

Most analysts now expect the Fed to cut by 25bp next week but that will be signposted as the only one for a while as the Central Bank considers the effect on the economy. This will be considered as “insurance” should the economy start to slowdown significantly in the coming months.

Equity markets have leveled off near their all-time highs despite the slight disappointment that rates will not be cut more drastically. Investors are in a difficult position. They would like cuts since this provides stimulus to the market but can see the merit of rates remaining unchanged.

Even the President’s rhetoric has dried up somewhat as he starts to concentrate on his re-election campaign. He may even have “seen the light”, realizing that rate cuts only happen in a weakening economy and he wishes to portray “everything in the garden as being rosy” since the hikes which took place last year were in direct response to his tax cuts and other stimuli.

The GDP report for the second quarter which will be released on Friday may awaken Trump, however, as growth is likely to have fallen below 2% in the period between April and June.

The dollar index reacted to a weakening euro following the poor Eurozone data but anything above 2.1% or 2.2% on Friday could light the blue touch paper on a significant dollar rally. It reached a high yesterday of 97.82, closing at 97.70.