Trump threatens China with more tariffs, again, Higher UK wages, but stalling inflation?

It happened again.

US President Donald Trump spoiled the expectations of a US – China trade deal yet again, after he said he could impose more tariffs on Chinese goods, claiming that Beijing pledged, but didn’t increase purchases of US farm products following the G20 summit.

US equities gave back gains. The S&P500 closed 0.34% lower, breaking a five-day winning streak. Dow Jones and Nasdaq fell off their all-time highs as well.

The US dollar gained on Tuesday, after the data showed 0.4% m-o-m expansion in US retail sales in June versus 0.2% expected by analysts. But the industrial production stalled, and the capacity utilization eased from 78.1% to 77.9% during the same month.

In his speech in Paris, the Federal Reserve (Fed) Chair Jerome Powell repeated that the Fed will act appropriately to support the economy. Investors take a 25-basis-point interest rate cut as granted in July, while the probability of a 50-basis-point cut stands at 25% according to the activity in US treasury markets.

But that’s not all. The Fed is also talking about launching a new monetary policy tool: standing repurchase agreement facility (SRF), which should allow the eligible banks to convert their treasury holdings into reserves on demand. FOMC members will likely dig into the possibility of introducing this new tool to increase the incentive for banks to hold a greater amount of treasuries in their books and to have a better control on the short-term rates. Hence, SRF discussions could be another dovish surprise for the market in FOMC’s July meeting, if the Fed refrains from lowering the benchmark rate by 50 basis points. But the Fed will unlikely announce any concrete steps before the September meeting and the new tool will probably not see the day light before the end of 2019, or the first quarter of 2020.  

The US 10-year yield settled a touch below the 2.10% mark. Gold is down to $1403 an ounce, but there is a decent buying interest near the $1400 mark as downside risks on US yields prevail.

US equity futures were muted in Asia, and the FTSE futures (-0.23%) hint at a slightly softer start in London.

FTSE is expected to open 20 points lower at 7557p.

UK’s higher wages may not translate into higher inflation

The pound has been the biggest loser against the greenback among the G10. Cable fell 0.83% since Monday, and that, despite the encouraging economic data released in London yesterday.

Britain’s labour market, for example, has not been in such good shape in the past four decades. UK’s unemployment rate stands at 3.8%, the lowest since 1975, and British employees’ salaries grow at the highest pace since the subprime crisis. The average weekly earnings grew 3.4% in three months to May, versus 3.1% printed a month earlier. The earnings’ growth improved up to 3.5% at the beginning of this year.

So, it is no surprise that the improved labour market pulled the UK consumer price inflation from 1.8% to 2.1% between January and May. What is surprising is that solid jobs and wages growth didn’t exercise a sustained upside pressure on inflation. The inflation in the UK eased to 2.0% in May and may have remained unchanged at this level in June.

If lower unemployment and higher wages don’t translate into increased consumer spending and higher price inflation as suggested by the Philips curve, then there is no reason for the Bank of England (BoE) to tighten its interest rates in the foreseeable future. UK policymakers would do better to tune their monetary policy according to global trade tensions and of course, the increasing odds of a no-deal Brexit. That means a more supportive action plan.

If, however the inflation surprises on the upside at today’s release, the pound could rebound on more hawkish, or less dovish BoE expectations. Only a solid inflation figure could temporarily ease the selling pressure on the British pound.  

Speaking of the Philips curve puzzle

The Philips curve puzzle is also true in the US and the Eurozone. The negative relationship between the unemployment and inflation doesn’t seem to hold anymore. This is certainly because the ratio of consumption to savings is lower in developed economies. Households prefer sitting on their savings as a result of a decade-long financial crisis, even though their return on savings are close to null due to low-to-negative interest rates.

As such, Eurozone’s decade-low unemployment rate do little to improve consumer prices. In contrary, the euro-area inflation expectations fell to an all-time low in June.

Eurozone’s June final inflation figures are due today. The headline euro-area inflation is seen at 1.2% y-o-y and the core inflation at 1.1%. The 5-year/5-year euro inflation swap forward, which is used as a prime gauge of inflation expectations, rebounded from June’s historical low of 1.13% to nearly 1.30% in July, after the European Central Bank (ECB) pledged to further ease its monetary policy. The ECB is preparing for another round of TLTRO (Targeted long-term refinancing operation) and is even expected, with 90% probability, to lower its deposit facility rate by 10 basis points to -0.50% by December. Cheaper liquidity may not lift the consumer prices toward the ECB’s 2% target, but the dovish expectations should continue weighing on the single currency.

The EURUSD is testing the 1.12-support. Put option expiries prevail below the 1.12 mark.

Opening calls

FTSE is expected to open 20 points lower at 7557

DAX is expected to open 20 points lower at 12410