Trump calls into question Fed’s independence

Summary:

• US President Donald Trump questions Federal Reserve independence sending the buck much lower
• Chinese yuan keeps tumbling as PBoC sets the CNY reference point much lower
• Japanese inflation in June stays a long way off the BoJ’s target

Yesterday’s remarks of the US President Donald Trump with respect to the Federal Reserve were pretty unprecedented. Trump openly criticized the US central bank for hiking interest rates which are seeing the US dollar much stronger over the recent weeks. He said that the strong currency puts the US economy at a disadvantage versus others. Immediately after these comments the greenback experienced a heavy reversal trimming its all gains it had made prior to the Trump’s statement. Even as these kind of words coming from him do not seem to be particularly new, he went further this time. "Now I’m just saying the same thing that I would have said as a private citizen, so somebody would say, ’Oh, maybe you shouldn’t say that as president. I couldn’t care less what they say, because my views haven’t changed", Donald Trump said on Thursday. If I am not mistaken it could have been the first time when the US President so explicitly referred to monetary policy conducted by the Federal Reserve, but when it comes to Trump you never know what can happen. His remarks quickly spread through all classes of assets weighing on the greenback and supporting commodities’ prices.

The EURUSD jerked higher in the aftermath of Donald Trump’s criticism of the Federal Reserve. Source: xStation5

However, can these comments daunt the Federal Reserve? I suppose that these remarks might even backfire on Donald Trump. The Federal Reserve has been underlining its independence in conducting monetary policy for ages, hence it is hard to imagine that Trump could influence the real path of interest rates. On the flip side, Jerome Powell could be even more eager to keep raising interest rates, and the Fed might become slightly skewed toward a more hawkish stance e.g. when economic conditions get rough, the central bank might want to think twice it is a reasonable signal to stop lifting borrowing costs. Anyway, looking at the EURUSD one may notice that the pair bounced off its lower bound, and it is currently heading higher. The first goal bulls might aim for is the upper boundary of the descending channel, and breaking through it would see the EURUSD rising further even toward 1.1850.

Meanwhile, the People’s Bank of China does not seem to even think about taking downward pressure off the yuan. The Chinese central bank set the reference point for the onshore yuan above 6.76 from above 6.70 on Thursday despite a massive reversal seen in the greenback. It was the biggest daily cut since June 2016 and contributed. Nevertheless, Chinese stocks have been able to resist to this clear negative factor, and have surged a while before the close. At the time of writing (6:39 am BST) the Shanghai Composite as well as the Hang Seng (CHNComp on xStation5) are rising 1.1% each. However, ongoing yuan devaluation is not a reassuring signal for the longer-term backdrop as it acts in the same way as tariffs making imported goods more expensive in the eyes of Chinese people.

Yuan monthly and annual implied volatility has increased appreciably of late raising concerns about a capital outflow. Source: Bloomberg

Notice that the weaker currency the higher likelihood to see a capital outflow, and this was already seen earlier this year when the Chinese economy reported its first current account deficit (in yuan terms) since the beginning of the millennium. To sum up, CA deficits are equal to a capital outflow which might lead to the weaker currency constituting a risk to financial stability.

In turn, looking at the overnight macroeconomic calendar one may glance at Japanese inflation figures. While at the national level price growth excluding fresh foods met expectations coming in at 0.8% in June, there were disappointments elsewhere. Headline CPI showed a 0.7% increase missing the consensus at 0.8%, whereas core price growth stripping out fresh food and energy grew just 0.2% falling short of the median estimate at 0.4%. The inflation report did not constitute a breakthrough at all, and one may expect it will not transpire in the foreseeable future.

The US dollar index (USDIDX) is getting back from above its crucial technical level as the week is coming to an end. Should the price be capable of staying below 95, it would suggest possible declines in the coming weeks. Source: xStation5