FOMC to signal rate cut this week?

This is likely to be a defining week for U.S. monetary policy. It remains unclear if the current slowdown is either a blip or something more serious, which make it difficult to understand the Fed’s position.

So far, FOMC members, including Chairman Jerome Powell, have been ambiguous in their view of just how serious any slowdown will be. Economic data has not helped either with the employment report producing data which one month points to continued growth and the next to a recession while the three-month moving average remains right in line with market expectations.

The poor data for May was clouded by various one-off factors while falling output and uncertainty over further tariffs on Chinese imports have hit both manufacturing and industrial output.

It remains doubtful that Powell will give too much away on Wednesday, almost certainly continuing to stick to the Central Bank’s data-driven stance.

Today’s NY Empire State Manufacturing Index is expected to provide further ammunition to the doves possibly falling from 17.8 in May to 12.75 this month. That will be a factor in the Fed’s thinking but as Powell has said on several occasions, it is the trend, not one-off figures, that he and his colleagues are most interested in.

As Q2 comes to an end, there is little doubt that GDP for the quarter will be significantly lower than Q1 which came in at 3.1%. When the Q2 data is released towards the end of next month anything around 2.7% will bring a degree of relief to the markets.

The dollar index had a mixed week, managing to recover most of its losses from the previous week. It closed at 97.55 just four pips below its high.

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Johnson’s position strengthened as “vote 2” looms

The name of the candidate who will face off against Boris Johnson for the Conservative Party Leadership should be known this week with ballots to be held tomorrow, Wednesday, and Thursday (if needed) and the names of the two most successful candidates being put to the wider Party membership on 22nd June with the result expected a month later.

This period of limbo over Brexit has been a double-edged sword. On the one hand, with the clock ticking down towards October 31st, a six-week hiatus was not exactly ideal, while the delay could also be viewed as a useful “cooling-off” period.

It remains to be seen just what effect the break will have although by the time the result is official it will almost be time for Parliament to break for its summer recess. It could be that the new Prime Minister may set an earlier return date for MPs in order to “get on” with his Brexit plans.

Aside from politics, the Bank of England Monetary Policy Committee will meet this week. It will be the first meeting since the leadership candidates set their stalls out over a no-deal Brexit and it will be interesting if their views turn a little more dovish towards the economy, despite inflation starting to tick back up above the Government’s 2% target.

Governor Carney will probably remain cautious but optimistic but won’t allude to his attitude towards the various candidates Brexit visions He will prefer to wait and see what, if any, actions are necessary.

Last week, the pound fell back versus the dollar but more considerably so versus the euro. Against the greenback, the pound remained pretty much within its recent range, trading between 1.2759 and 1.2579. Versus the single currency, it fell to a low of 1.1191, closing at 1.1231.

Italy determined to remain a “thorn in Brussels side”

There is an almighty row brewing between Rome and Brussels over Italian debt and its budgetary proposals.

There has been talk of a €3.5 billion fine being levied against Rome for breaking its debt ceiling.

The coalition Government is united in its defiance of this move and is threatening to issue what it calls a “mini-BOT”. This is a system of issuing domestic debt, which is technically not allowed by Eurozone membership, but without an explicit Government guarantee.

The issuance of a “domestic currency” (mini-BOT stands for mini-bills of treasury) would rock the foundations of the entire Eurozone and could lead to other heavily indebted nations following suit which would wreak havoc with any budgetary constraints Brussels has set in place.

The mini BOTs would be able to be used to pay Government workers and could then be exchanged for payments which would eventually flow back to the Government and recycled.

Since they would not be backed by the guarantee of the Government (the coalition will design an implicit guarantee to provide a degree of comfort to the holder) they do not technically fall foul of Brussels regulations.

This is being seen as something of a doomsday scenario by EU officials and could eventually lead to the collapse of the entire Eurozone.

The threat to issue to mini BOTs is currently seen as a bargaining tool by Rome to ward off the threat of a huge fine but it could become a practical consideration if the coalition feels it has the support of the nation for such a move in the future.

Inflation data is due to be released tomorrow with the headline expected to remain at, or very close to, 1.2% YoY. So, another month ticks by without the rise in inflation that has been predicted if not promised by ECB President Mario Draghi.

As the economy teeters on the brink of recession, it remains to be seen if this will simply be a prolonged downturn that will hinge on an improvement in global trading conditions or a more systemic slowdown. For an answer to that puzzle, we need to hope for a breakthrough between the U.S. and China which currently seems some way off.

The euro traded as a mirror image of the dollar last week, retracing its gains from the week before. It reached a low of 1.1202 and closing at 1.1209.