USD runs into resistance while Trump administration suffers setbacks

USD: Setbacks for the Trump administration amid record US govt. shutdown

The major foreign exchange rates have remined stable overnight with EUR/USD trading just above support at the 1.1500-level. The dollar index recorded its sixth day of gains yesterday but has run into resistance from the 200-day moving average that comes in at around 100.30. The US dollar derived support yesterday from the release of the stronger than expected ADP and ISM services surveys for October. The ADP survey estimated that private sector employment rebounded by 42k in October following a contraction of 29k in September. It was the strongest reading since July when private employment was estimated to have increased by 104k. It compared to actual nonfarm private employment of 77k in July. Nevertheless, recent ADP survey readings that have been released during the ongoing US government shutdown still point to weak labour demand in the near-term. The ADP survey has estimated private employment growth has averaged just 6.5k/month in both September and October. If the delayed nonfarm payrolls reports for those months are finally released ahead of the next FOMC meeting on 10^th December and confirm similar weakness in employment growth it would support our forecast for another 25bps Fed rate cut. It helps to explain why support for the US dollar from yesterday’s stronger ADP survey was only limited. At the same time, the latest ISM services survey revealed that business confidence rebounded more strongly than expected in October when it rose to the highest level since February driven by a sharp 5.8 point improvement in the new orders component. There was also a more modest improvement in the employment sub-component by 1.0 point although it continued to remain weak at 48.2 in October. The prices paid sub-component is watched closely to assess the inflationary impact from tariffs and it rose to a fresh high of 70.0 in October although is little changed since July. Overall, the data points to continued divergence between stronger economic growth and labour market weakness that had been evident prior to the US government shutdown. We are still waiting to see how the unusual divergence will be resolved.  

The Trump administration has come under more pressure to bring an end to the government shutdown this week after the disappointing election results for the Republican party who lost to Democrat candidates in Virginia, New Jersey, and New York City. While in California voters approved Proposition 50, a redistricting measure that could cost the Republicans up to 5 congressional seats. President Trump has acknowledged that the government shutdown which is the longest in history was likely a major factor in the GOP’s poor performance. While it is still early days, the election defeats are a worrying development for the Trump administration ahead of next year’s mid-term election. The Trump administration suffered another blow yesterday after the initial hearing of the US Supreme Court on the legality of President Trump’s right to impose tariffs using the 1977 International Emergency Economic Powers Act. According to reports, a clear majority of the Justices appeared sceptical that IEEPA authorizes the type of broad-based tariffs that Trump has put in place. While the final ruling is not expected for a couple of months, it will put pressure on the Trump administration to draw up backup plans. These could include invoking Section 122 to maintain 15% tariffs for 150 days to buy more time for other alternative options.              

BOE RATE CUT EXPECTATIONS HAVE WEIGHED ON GBP

Source: Bloomberg, Macrobond & MUFG GMR

GBP: Dovish hold or another quarterly rate cut from the BoE?

The main focus today will be the BoE’s latest policy update. The pound has weakened ahead of the policy update as market participants have moved to price back in more rate cuts following the release of the softer UK CPI report for September, further evidence of soft UK labour market conditions including slowing wage growth, and building expectations for the UK government to set out plans for significant tightening measures totalling around GBP20-40 billion in the upcoming Autumn Statement. The UK rate market is currently pricing in around 6bps of cuts for today’s MPC meeting and 17bps by the December MPC meeting. It fits with our view for a dovish hold today that sets up a rate cut at the next MPC meeting in December.

However, we acknowledge that that there is a high risk that the BoE may decide not to wait until December and just continue with quarterly rate cuts today. A development that could trigger a further sell-off for the GBP by encouraging the UK rate market to price in more active rate cuts going forward as well. The UK rate market is pricing in just over 50bps of cuts for the year ahead compared to our forecast for the policy rate to be cut by 75bps to a low of 3.25%. On the other hand if the BoE leaves the policy rate on hold today, the pound could stage an initial relief rebound but we expect it to be only short-lived. The updated policy communication is likely to signal that another rate cut will be delivered soon in December. Market participants will be watching how close the vote is and the new communication from the BoE showing each MPC member’s own views on policy to better judge the likely timing and scale of further easing. The main rationale for leaving rate on hold today are that it allows the BoE to better assess if softer inflation continued into year end, and by the December MPC meeting they will have the final details of the government’s fiscal plans. Overall, the developments should remain supportive for our long EUR/GBP trade recommendation.

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com