Johnson or Hunt’s Brexit plans blown off course by Iran

Iran’s detaining of a British registered oil tanker threatens to make the new Prime Ministers first week in office vastly different than either he or the public imagined.

If, as expected, Boris Johnson is elected a Prime Minister, his first job will be to defuse a situation which is threatening to spiral out of control. It is obvious that the UK is being used by Iran as a proxy for Iran’s attempts to draw a response from the U.S. President Trump is managing to “keep his powder dry” although U.S. troops have been moved to U.S. bases in Saudi Arabia.

Once Hunt or Johnson takes over from Theresa May, the first order will be to create a new Cabinet. It is rumoured that Johnson will insist that every person he chooses will be willing to pledge agreement with his view on Brexit: to leave the EU by 31st October come “hell or high water”.

Chancellor of the Exchequer Philip Hammond has confirmed that he will resign to Theresa May should Johnson win on Tuesday.

The wildly differing views on the cost or otherwise of Brexit were highlighted with the Office for Budget Control predicting a cost of around £40 billion and a 2% hit to GDP

Sterling was in a reactive mode last week as the House of Commons voted to make it more difficult but not impossible for the UK to leave without a deal on October 31st.

Versus the dollar, it traded in a range of 1.2382 to 1.2579 on the week closing at 1.2503. It has now made the same high on two successive weeks. Against the euro, it traded between 1.1167 and 1.1048 closing at 1.1144.

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Rate cut to be 25bp

The financial markets have now accepted that the Federal Reserve will cut rates at its meeting which will be held on July 30/31. They have also accepted that the cut will be 25bp and will be treated as both a reversal of the rather aggressive third hike which took place last Autumn and “insurance” for the economy against any future shock.

This week sees the release of the preliminary data for GDP in the second quarter. There is an expectation that the economy will have grown at around 2% between April and June although there are fears that it could have dropped even further from the 3.2% seen in the first quarter.

The data will be released on Friday preceded by PMI’s on Tuesday and Durable Goods Orders on Thursday.

With the FOMC meeting taking place the following week preceding the July employment report on August 2nd, the dollar is likely to be volatile over the next couple of weeks.

Trade talks are set to resume between Washington and Beijing and while tensions continue to mount in the Arabian Gulf, traders will want to keep positions small. Liquidity could also be an issue with the European holiday season starting.

The market considers a single 25bp rate cut as dollar positive as long as Fed Chairman Jerome Powell isn’t too dovish in his remarks following the announcement.

Last week the dollar index traded between 96.67 and 97.45 as the markets took stock of comments from FOMC members.

Euro remains mired in poor data

In the short/medium term, there is little expectation of positivity from the Eurozone economy and therefore the single currency is unlikely to improve.

This week sees the release of Purchasing Managers Indices and they are expected to confirm that the economy remains sluggish although there has been little further deterioration.

Manufacturing will continue to contract overall, remaining around 47.6. German data will also be released and that is expected to have improved slightly moving to 45.3 from 45.00 in June.

The ECB will meet on Thursday and Mario Draghi will remain dovish on the economy and there may be confirmation that the target rate for inflation is about the be lowered.

With little more that can be done other than the wait out the slowdown, the ECB will be left with little to say that hasn’t been heard before.

The euro remains supported around the 1.1200 level versus the dollar, reaching a low of 1.1199 last week. It traded as high as 1.1285, matching the previous week’s range almost exactly.

While the dollar remains driven by the market’s view of a rate cut, the euro is unlikely to rally above 1.1300.