Said President Trump, “I’m not thrilled”
With how Chairman Powell’s fulfilled
Both job and price mandates
By raising Fed Fund rates
‘Cause soon the Dow Jones could get killed

“I’m not thrilled. I don’t like all of this work that we’re putting into the economy and then I see rates going up. I am not happy about it. But at the same time I’m letting them do what they feel is best.” So said President Trump in an interview on CNBC yesterday afternoon. It should be no surprise that the FX market response was immediate, with the dollar reversing earlier gains.

While this is not the first time that a US president has tried to persuade the Federal Reserve to cut rates (they never want higher rates, I assure you!), it is the first time since George H.W. Bush pushed then Chairman Greenspan to reduce rates more quickly in 1992 (he didn’t). This is a situation fraught with serious consequences as the independence of a nation’s central bank is seen as one of the keys to a developed economy’s success. For instance, recall just several weeks ago when Turkey’s President Erdogan essentially took over making monetary policy there, and how the market has behaved since, with TRY already significantly weaker.

As long as the Fed remains on course to continue raising rates, and despite the Trump comments, Fed Funds futures showed no change in the probability for two more rate hikes this year, I see little reason to change my stance on the dollar’s future strength. However, the bigger problem is if the Fed, independently, decides that slowing the pace of rate hikes is justified by the data, it could still appear to be politically motivated, and so reduce whatever credibility the Fed still maintains. This will remain a background story, at the very least, for a while. So far, there is no indication that Chairman Powell is going to change his stance, which means that policy divergence remains the lay of the land.

In the meantime, the other big FX story comes from China. We discussed yuan weakness yesterday and in the overnight session, the PBOC fixed the onshore currency at its weakest point in more than a year, which in fairness is simply following the dollar’s overall strength, but then when USDCNY made new highs for the year above 6.83, a large Chinese state-owned bank was seen aggressively selling dollars. This tacit intervention helped to steady the market and worked to support the Shanghai Stock Exchange as well, which ultimately rose 2.0% on the day. It is, however, difficult to follow all the twists and turns in the US-China relationship these days, as literally minutes ago, President Trump raised the ante yet again, by saying that he is “ready to go” with regard to imposing tariffs on $500 billion of Chinese goods. That represents all Chinese exports to the US and is considerably larger than ever mentioned before.

Tariffs and protectionism have a very poor history when it comes to enhancing any country’s economic situation, but it is very possible that this continuous ratcheting of pressure may actually be effective at achieving policy changes in this situation as China has plenty of domestically created economic problems already. Recall, President Xi has been on the warpath about excess leverage and the PBOC had been tightening policy in order to squeeze that out of the system. However, growth in China has suffered accordingly, and the recent data indicates that it may be slowing even more. With that in mind, a full-scale trade war with the US would likely be disastrous for China. The last thing they can afford is to see reduced production numbers, as well as loss of access to critical component and technology imports. It is not impossible that Xi blinks first, or that the two presidents recognize that a face-saving deal is in both their interests. It may take a little while, but I have a sense that could well be the outcome. However, until then, look for USDCNY to continue to rally sharply, with a move to 7.00 and beyond very viable. This morning, despite the intervention overnight, it has subsequently weakened 0.4% and shows no signs of stopping.

Finally, one last story has returned from the past to haunt markets, Italy. There appeared to be a push by Five-Star leader, Luigi di Maio, to have the Finmin, Giovanni Tria, removed from office. You may recall that back in May, things got very dicey in Italy before the current government was finally formed as President Mattarella rejected the first proposed cabinet because of the Euroskeptic proposed for the FinMin post. Tria was the compromise selection designed to calm markets down, and it worked. So, if he were forced out, and it has been denied by the Finance Ministry that is the situation, it could lead us right back into a euro area crisis. This is especially true since the populist coalition of the League and Five-Start has gained further strength in the interim. While Italian bond markets suffered on the news, it was not sufficient to impact the euro much. However, we need to keep an eye on this story as it could well resurface in a more malevolent manner.

And that is really today’s situation. Overall the dollar is mildly weaker, but given its performance all week, that has more to do with profit taking on a Friday than other news. Clearly the Trump comments undermined the dollar to some extent, but until policies are seen changing, I think that will only be a temporary situation. With no data due this morning, and no speakers on the agenda, it has all the feelings of a quiet day upcoming. It is, after all, a Friday in July, so the summer doldrums seem appropriate.

Good luck and good weekend
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