Investors do not seem keen in buying EUR because they are
worried about the political situation in Italy, the possibility of a recession
in Germany, the prospect of aggressive easing from the European Central Bank
and the ongoing risk of more tariffs from the US on Chinese goods. This week,
Italy's Prime Minister Conte resigned, turning crisis into chaos for the
Eurozone's third largest economy. Of all the EUR troubles, Italian
politics has the most limited impact on the currency. Europe is no
stranger to Italian political uncertainty (they just had elections in 2018 and
who can forget Berlusconi's countless scandals) and this crisis was a long time
coming. Instead of rising, Italian bond yields fell because investors are
hoping that the new government will be more pro-business. Talks have already
begun to form a majority in Parliament, which could hopefully pave the way for
a smooth transition for Matteo Salvini, who is widely expected to become the
new Prime Minister.
Recession on the other hand is a serious risk for Germany.
According to the Bundesbank, Germany's central bank, the country could very
likely fall into a technical recession in the third quarter. Last week they
predicted that GDP could continue to fall slightly. Growth has been weak
for the past year as the country posted growth in only one out of the last four
quarters. Unlike Italy, Germany is a serious problem for the Eurozone. As the
region's largest economy, their slowdown will be felt across the continent.
Although, it became evident last week that German and EZ PMIs rose in the month
of August, the uptick in activity won't stop the European Central Bank from
easing. Industrial production is weak, investor sentiments are
bearish and there's a good chance that the upcoming German IFO business
confidence index will decline as well. Auto sales have taken a big hit and
fears of further tariffs along with a disorderly Brexit are
mounting. Just this past week, the US lawmakers urged the Trade
Representative's Office to hold off imposing new tariffs on European olive oil.
In November, the Trump Administration will decide whether to impose duties on
European autos. With all of these risks in mind, the European
Central Bank will have no choice but to ease next month and they could deliver
a bigger than expected stimulus package. This prospect will keep
EUR/USD under pressure.
Meanwhile the US Fed is really going out of its way to
downplay the need for easing. According to the FOMC minutes, most
Fed officials saw the July rate cut as a mid-cycle adjustment and not the start
of an aggressive easing program. Since then comments from
policymakers such as Mester, Rosengren, George, Daly and Harker suggest that
they may not support another rate cut. On Monday, Rosengren said the
US is in a good spot right now and there is no need to take action if their
outlook stays on track. He stressed that the Fed doesn't have to ease simply
because other countries are weak. On Tuesday, Fed President Daly said she
supported the July cut but sees the labor market as strong and consumer
spending. Fed President George seems to agree - she said just this morning that
she's not ready to provide more policy accommodation without seeing evidence of
a slowdown. Like Rosengren, she described the economy as in a good
place. Fed President Harker admitted that he reluctantly supported the
July rate cut and felt that "we should stay here for a while, see how
things play out." So while President Trump wants the Fed to be
proactive and has taken every opportunity this week to lay on the pressure, US
policymakers don't seem to be onboard with the idea. If that's true,
it would be significantly misaligned with market expectations as Fed fund
futures price in 100% chance of easing next month. Now it is all up
to Jerome Powell to clear the air. He is scheduled to talk on Friday and the
tone of his speech could determine the direction for USD in the weeks ahead.
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