Fed turmoil: Trump ousts Cook and markets react

Markets

The single currency’s short-term fortunes took a dramatic turn yesterday following a surprise announcement by French PM Bayrou. He asked back French parliament by September 8 instead of October 1st and immediately tabled a confidence vote in his minority government on fiscal plans (outlined in July) to bring bloated public finances back on a sustainable trajectory. Bayrou’s government is at huge risk of collapsing. If a vote of no confidence is called by the opposition, abstaining (eg Socialists) equals supporting the government. If the confidence vote is called by the government, abstaining doesn’t count as a valid vote. So the majority of voting members decides the outcome with the extreme right Rassemblement National and far-left leader Mélenchon already calling to vote against PM Bayrou. RN Le Pen suggested early elections to break the deadlock from the current hung parliament. EUR/USD dropped from 1.17+ levels to the low 1.16 area after the announcement, erasing USD-losses triggered by Powell’s dovish pivot in Jackson Hole on Friday. EUR/USD that way risks becoming a balance of weakness with the euro held back by rising French risk premia and the greenback vulnerable to loss of interest rate support in case of disappointing US eco data. Durable goods orders, housing data, the Richmond Fed manufacturing index and the conference board’s consumer confidence are on tap today. The pair could as a result extend its stay in this Summer’s trading range between 1.1392 and 1.1829. The French 10y swap spread added 5 bps yesterday (80 bps) with this year’s high (88 bps) being the next target before possibly taking aim at the all-time (2011) high at 120 bps. German Bunds outperformed intraday, drawing safe haven flows when news broke. German yields still added 2.3 bps (30-yr) to 3.8 bps (5-yr) on a daily basis. Risk assets corrected following Friday’s (exaggerated) enthusiasm with key US and European indices losing up to 0.75% and the French CAC40 (-1.60%) underperforming.

The US dollar lost some ground overnight (EUR/USD 1.1640) after US President Trump fired Fed governor Cook effective immediately saying that false statement on mortgage agreements give him cause to fire her. Cook later disputed his authority, saying she won’t quit. The episode is a new low point in the president’s attacks on the independent central bank. It risks hurting the Fed’s credibility if Trump manages to pack the Fed with people wanting to implement his low interest rate agenda. US Treasuries briefly spiked higher on the publication of Trump’s letter. Dallas Fed President Logan said that US money markets could face temporary pressures around quarter-end next month suggesting that investors will likely tap the Fed’s overnight facilities again as they did in June. She nevertheless believes that the Fed still has more room to reduce reserves (via balance sheet reduction)

News and views

UK BRC shop price inflation increased from 0.7% Y/Y in July to 0.9% Y/Y in August, the fastest pace since March last year and well above the 3-m moving average of 0.6%. Non-food prices fell 0.8% Y/Y (from -1% in July), but food price inflation accelerated to 0.4% M/M and 4.2% Y/Y (from 4% in July). The Bank of England earlier this month indicated that higher food prices are a potentially important driver for consumers’ inflation expectations. According to BRC, aside from an unfavorable supply-demand balance, the rise in shop prices is still driven by the cost of government measures flowing through to prices of households. Markets question whether there will be room for the BoE to continue its gradual pace of quarterly rate cuts this year.

Belgian business leaders turned more optimistic in August. The business climate improved in the manufacturing and building industries but weakened slightly in the trade and business-related services sectors. Business leaders in manufacturing (-10.5 from -13.5) assessed order books more positively, were more optimistic about demand expectations and for the third consecutive survey expect a rise in employment. Leaders in the building industry (-9.4 from -10.0) were more upbeat about the recent trend in equipment use and orders. Order books were assessed as being significantly weaker when considering the season, but they expect demand to pick up. A slight downturn for business-related services (-1.5 from -1.2) was due to softer expectations for both activity and general market demand, but the current level of activity was seen as more favorable than last month. Sentiment in trade also eased (-8.3 from -7.2). The overall synthetic smoothed curve, which reflects the underlying economic trend, remains on an upward trajectory (-8.9 from -10.8).

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