Sterling surged to its highest levels of the month yesterday afternoon, as Merkel and Macron served a two layered cake of warm words and offered Boris Johnson an opportunity to find a solution to the Irish border issue that has plagued Brexit negotiations. The two key developments this afternoon appear to be Macron hinting that the withdrawal agreement “can be amended while complying with the integrity of the single market…” and Merkel stating afterwards in the Hague that “we can work on finding a regime that keeps good Friday agreement and also ensures the integrity of the single market. Yesterday’s price action underlines the extent to which Brexit is the sole driver of the currency – headlines that suggest no deal has become less likely, however marginal, have the potential to cause significant sterling rallies. Sterling has since pared back some of yesterday’s gains.
The euro has been knocked another leg lower this morning amid broad US dollar strength, after a choppy afternoon yesterday. Monetary policy meeting minutes were released by the ECB yesterday, and showed that governing council members discussed changing the institution’s inflation target, as well as discussions of asset purchases combined with rate cuts. Italy’s politics remained in crisis, as the various potential parties of government laid out their demands for entering into a coalition. New elections seemed likely, with Italy’s President Sergio Mattarella saying that if a new government could not be formed quickly Italy would head to the polls. This weekend will see European leaders meet with the heads of other large economies in Biarritz, France, for the G7 summit. After US President Donald Trump ended the last meeting controversially after failing to endorse a joint communique, no such statement is planned, but there is plenty of potential for euro downside should Trump decide to talk up the prospects of a new front in the administration’s trade wars.
The US dollar remains ascendant this morning, with only NZD managing to post any meaningful gains overnight. Fed chatter was mixed overnight, with Kansas City Fed president Esther George saying that she didn’t think rates needed to fall in July – something we already knew from this week’s FOMC minutes. Dallas Fed chief Robert Kaplan was less hawkish, saying that he was open to another cut in September. Fixed income markets continue to price in substantial action from the Fed – no less than 100bp of cuts over the next year. In the meantime, President Trump has maintained a steady stream of attacks calling for rate cuts, both personal and institutional, at the Fed and chair Jerome Powell. The US macro picture remains mixed: even though domestic demand and business investment are showing signs of weakening, wages are growing and consumers are spending, so 100bp of cuts could plausibly be seen as increasing inflationary risk. Jerome Powell will wade into this febrile environment today at 15:00 BST with a watershed speech at the Federal Reserve’s annual symposium at Jackson hole. Although Powell is likely to try to steer clear of controversy by avoiding giving forward guidance on the likely path of rates, there is a chance he will be forced to address one of the many controversial issues facing the FOMC – and the US dollar.
The loonie is broadly flat this week, despite a week of firm data releases including strong inflation and wholesale sales. Today at 13:30 BST, Retail Sales data will be released. The Bank of Canada’s Poloz and Wilkins will be in attendance at the Jackson Hole symposium, but neither are expected to give speeches.