Sterling may have been the unexpected outperformer among the major currencies both on Friday and last week as a whole, after a string of strong data and a potential General Election-inducing vote of no-confidence in the current government. To recap, last week saw stronger wage growth and core inflation figures, which together with jubilant Retail Sales imply the Bank of England will jump on the rate hike lever if a hard Brexit is avoided. This remains a big if after Boris Johnson this weekend again showed he is willing to play hard ball over the UK exit from the European Union. He urged the EU to not take the domestic political attempts to prevent a no-deal scenario from happening as an excuse to not negotiate with him. Meanwhile, this morning British households surprised the world by indulging in a house-buying spree that saw UK house Sales up 6.1% year on year, according to Rightmove data. The focus of this week will be on the British Prime Minister’s visit to the German Chancellor Angela Merkel on Wednesday, followed by a rendez-vous with the French President Emmanuel Macron on Thursday. In the absence of Johnson, Labour leader Jeremy Corbyn may be sneaking through the hallways of Westminster, attempting to forge an alliance that holds enough support to have a vote of no confidence reach a majority in Parliament. If Corbyn’s attempt succeeds and he can convince the Liberal Democrats to back his plan, another extension of article 50 combined with the prospect of a General Election in Q1 2020 will be the newest game changer for sterling.
The euro looked lethargic on Friday, but managed to pare some losses after reports of German fiscal spending in case of a recession intensified. The German Finance Minister Olaf Scholz and German Chancellor Angela Merkel have signalled the German government is willing to spend €50 billion to counter the negative impacts of a possible recession. German fiscal spending has long been one of the positive tail risks for the Eurozone, as Germany’s fiscal position appears strong enough to increase spending without blowing up risks of a default. Also, there are plenty of infrastructure projects in Germany that warrant spending, while also the digital infrastructure is less advanced than many other European countries. An increase in German spending at this moment may boost growth if it indeed matches the shortfalls in demand that are currently starting to show in the private sector. However, some fear that given Germany’s current tight labour market, the extra spending will mostly be inflationary. This can still be a euro positive story either way, because higher inflation would force the European Central Bank to tighten its monetary policies. Nevertheless, as this spending may only come after a recession has started in Germany the overall effect on the single currency is ambiguous as the fiscal spending may not be sufficient to offset the weakness stemming from a slowdown in German growth. The Social Democratic Party, the junior coalition partner of Merkel’s Christian Democrats, do advocate for allowing higher deficits, also in time of growth. In the end, this remains the most potent upside risk for the euro coming from German fiscal policies. A risk for the single currency at this moment is definitely that the US will start a trade dispute with the Eurozone after fighting a trade war with China. At least, this is what can be distilled out of the words of President Trump who at a Party rally in New Hampshire.said that: “The European Union is worse than China, just smaller. It treats us horribly: barriers, tariffs, taxes,”.
The DXY dollar index reached the highest level in two weeks on Friday, remaining close to two-year highs, in an aftereffect of strong Retail Sales on Thursday and a call between the Chinese and the US Presidents that shows trade talks continue. Over the weekend White House Economic Advisor Larry Kudlow came forward with the message that he does not see any signs of an imminent recession. This is a reassurance to some, though some refer to the age-old adage that nothing should be believed until it has been officially denied. Nevertheless, Kudlow did open the door to further fiscal stimuli, with tax cuts financed by the income of the new trade tariffs being floated as an option. Political business cycle theory would indeed predict more fiscal spending in the year leading up to an election, which would be a boon to the dollar. On the short run at least, this will boost growth and the extra issuance of Treasury bills to fund this spending may cause a squeeze in liquidity in dollar markets, given the Federal Reserve doesn’t respond on this development. The sparseness of this week’s data calendar is more than compensated by the annual Federal Reserve meeting in Jackson Hole on Friday and Saturday and the G7 meeting in France, starting on Saturday.
The loonie was among the top FX performers on Friday, as it only needed to accept the Briitish pound one step higher on the G10 podium. This despite Foreign Security Purchases showing appetite for Canadian securities is not what it was last month, as almost 4 billion CAD flowed out of the country in June, after the strong 10 billion CAD inflow in May. So far this suggests that Canada’s decent yields and economic growth have failed to attract more flows of foreign funds into the country. This week promises to be an interesting week for the Canadian dollar with the Consumer Price Index on Wednesday and Retail Sales on Friday.