I Knew You Were Trouble

September 11, 2024

I Knew You Were Trouble

  • Betting markets suggest Vice-president Kamala Harris won the debate against former President Donald Trump. Taylor Swift endorses Harris.
  • UK economy stagnated for a second consecutive month in July. GBP underperforms.
  • BOJ Board Member Junko Nakagaw implied BOJ has room to crank-up the tightening cycle. JPY outperforms.

USD is lower against most major currencies, while futures on US equity markets and Treasury yields are down. Financial markets could be unwinding the “Trump trade” after betting markets (PredictIt) suggest Vice-president Kamala Harris won the debate against former President Donald Trump.

The current financial market reaction is the opposite to the post-June presidential debate response when Trump emerged as the clear winner against President Joe Biden. Following the June 27 debate, USD firmed slightly, Treasury yields rose, the yield curve steepened, and US stocks rallied. The macro logic is that fiscal and trade policies under a Trump presidency are inflationary, forcing the Fed to keep the policy rate restrictive for longer.

Regardless, the path to 270 electoral college votes is shaping-up to be a nail-biter. Some polls show Trump has slightly more states either solidly in his corner or leaning his way (here), while others give Harris the edge (here). Meanwhile, both candidates have narrow leads in the seven key battleground states that total 93 electoral votes. The “Sun Belt” states of Arizona, Nevada, Georgia, and North Carolina and the “Blue Wall” states of Pennsylvania, Michigan, and Wisconsin.

Financial markets will be guided today by the US August CPI report as it will help shape the magnitude of the Fed’s September rate cut decision (1:30pm London). In August, headline CPI is expected to rise 0.2% m/m and ease four ticks to a 41-month low at 2.5% y/y. Core is expected to rise 0.2% m/m and remain at a 39-month low at 3.2% y/y for a second consecutive month. The Cleveland Fed’s Nowcast model forecasts headline and core at 2.6% y/y and 3.2% y/y, respectively. We see upside risks to the CPI data because of the increase in the ISM services and manufacturing prices paid indexes.

As such, higher than expected US inflation in August can reduce the probably of a jumbo Fed funds rate cut in September and underpin a firmer USD. Fed funds futures have fully priced-in a 25bps cut at the upcoming September 18 meeting and are pricing an additional 30-40% chance of a 50bps cut.

GBP is underperforming. UK real GDP unexpectedly showed no growth for a second consecutive month in July. Consensus expectation was for real GDP to rise 0.2% m/m. The details show services output added 0.11pts to monthly GDP, while production and construction shaved -0.10 and -0.03pts off GDP, respectively. Nevertheless, leading indicators point to a pick-up in UK economic activity. This indicates the Bank of England is unlikely to slash the policy rate by more than is currently priced-in (-50bps by year-end) and offers GBP support.

EUR/USD retraced some of its recent losses ahead of tomorrow’s ECB policy rate decision. The ECB is widely seen cutting the key deposit facility rate (DFR) 25bps to 3.50%. The ECB is also expected to slash the rates on the main refinancing operations (MRO) and marginal lending facility (MLF) by 60bps to 3.65% and 3.90%, respectively. This would be in line with the changes to its operational framework for implementing monetary policy announced in March. Specifically, the ECB wants to narrow the MRO-DFR spread from currently 50bps to 15bps and keep the MRO-MLF spread at 25bps. The narrower MRO-DFR spread is aimed at improving liquidity condition and steer short-term money market rates closer to the ECB's monetary policy decisions.

Moreover, we anticipate the ECB to maintain its cautious easing guidance that “It will keep policy rates sufficiently restrictive for as long as necessary” and “follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction.” The update macroeconomic projection will likely offer better policy guidance. Inflation is tracking the ECB projection. But sluggish Eurozone economic activity suggests the risk is the ECB tweaks lower its inflation and real GDP growth forecasts. This can lead to a downward adjustment to Eurozone interest rate expectations against EUR.

JPY is outperforming as Japan equity markets slide. Hawkish comments by Bank of Japan (BOJ) Board Member Junko Nakagaw accelerated the rally in JPY. Nakagaw stuck to the bank’s hawkish guidance noting “the degree of monetary easing will be adjusted if the outlook for Japan’s economy and inflation is realized”. Nakagaw added “the current level of real rates is extremely low”, suggesting the BOJ has room to crank-up the tightening cycle. Indeed, the real policy rate is negative at around -2.7%. Still, we doubt the BOJ will tighten more than is currently priced-in (25bps over the next 12 months) because Japan underlying price pressures remain low and economic activity is soft. This will limit JPY upside momentum.

AUD/USD is firmer above 0.6650 on broad USD weakness. RBA Assistant Governor (Economic) Sarah Hunter gave a talk about Australia’s labor market. Hunter pointed out “the labor market is still tight relative to full employment”, and the RBA’s view is that “further falls in vacancies can still occur alongside a relatively modest increase in the unemployment rate.” The comments support the RBA’s case against near-term policy rate cuts. However, we expect the RBA to join the global easing cycle later this year because Australia underlying economic activity is weak and points to lower inflation pressures. The likelihood of a dovish RBA pivot is a drag for AUD.

 

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