Market Recognizes US Tariff Threats as Negotiation Tactics and Sees Through New Front in Criticism of Powell

Overview: The market has taken the US threat of 30% tariffs on the EU and Mexico in stride. Both currencies wobbled a little but are little changed as the North American session is about to start. Participants seem to recognize the threat as a tactic meant to increase the pressure to negotiate (i.e., make new concessions). Market participants also do not seem to give much credence to claims that cost overruns at a remodeling the Federal Reserve headquarters will give President Trump the justification he has been looking for to fire Chair Powell. The dollar is narrowly mixed against the G10 currencies. The Dollar Index has marginally extended its gains. It has not posted a closing loss since July 2. Emerging market currencies are also mixed. The offshore yuan is slightly firmer after posting a wider than expected trade surplus and stronger aggregate credit growth. 

Equities are mostly weaker today. In the Asia Pacific area, most of the large bourses were lower but China, Hong Kong, and South Korea. The MSCI Asia Pacific Index has fallen for the past two weeks. Europe's Stoxx 600 fell by 1% before the weekend, the largest decline in three months. It is off another 0.3% today. US index futures are nursing modest losses. The S&P 500 and Nasdaq made set record highs last Thursday before pulling back ahead of the weekend. The earnings season kicks off properly with several large banks on Wednesday. Benchmark 10-year yields played catch-up after the rise in the US and Europe before the weekend. Japanese long-dated bond sold off sharply. European yields are narrowly mixed, while the 10-year US Treasury yield is up around a basis point to 4.42%. Gold is firm near $3366 after reaching $3375 in Asia Pacific turnover. August WTI rose to about $66.60, its highest level since June 23. President Trump is expected to make an announcement about Russia today and some suspect it could include stepped up efforts to restrict Russia's oil sales. 

USD: The Dollar Index rose every session last week and its 0.65% gain, as modest as it is, was the largest weekly gain in two months. The five-day moving average is poised to move above the 20-day moving average for the first time since May 22. It has edged up to 98.10 today. A push above 98.25 is needed to be anything noteworthy from a technical point of view, and even then, a gap from last month extends 98.35. Tomorrow's CPI is arguably the most important data point of the week, which also sees industrial production, retail sales, and import prices. The low base effect and the 0.3% rise that the median of economists polled by Bloomberg expect will translate the highest year-over-year rates since February. Last week's minutes from the recent FOMC meeting suggest that the threshold to cut interest rates is still not at hand. At the end of June and early July, the Fed funds futures had a September cut fully discounted. Now it is less than 75% priced. Meanwhile, the White House and its allies think that the renovations at the Federal Reserve will give the president "cause" to fire Fed Chair Powell. Although some observers are taking it seriously, the market is not. 

EURO: The euro has been drifting lower since the $1.1830 was approached on July 1. It fell to about $1.1665 by the end of last week, where the 20-day moving average is found. While it has exceeded the (38.2%) retracement of the rally since June 23, it has stopped short of the (50%) objective near $1.1640. It slipped a little closer to it today (~$1.1650) and is extending its losing streak for the fourth consecutive session. A break could target $1.1600 initially. On Saturday, the US indicated that barring a successful conclusion to the trade talks, EU goods will be slapped with a 30% levy. The market understands this to be a negotiating tactic. The week's data highlights are tomorrow. The eurozone reports May industrial production and Germany sees the ZEW investor survey. After imploding by 2.4% in April, industrial production may have stabilized in aggregate but that masks a strong divergence:  a recovery in Germany and Spain, but a continued contraction in France and Italy (and down more than expected). Sentiment among German investors is gradually improving, arguably encouraged by the coming infrastructure and defense spending. 

CNY: The PBOC has introduced a little more flexibility in the exchange rate and tolerated a modest appreciation of the yuan. The average daily change in the midpoint of the dollar's allowable range has become greater in recent months. The yuan is rising against the dollar but at a gradual pace. The 1.8% gain is a little more than implied by the 10-year interest rate differential or inflation differential. The PBOC is accommodating. It set the dollar's reference rate before the weekend at its lowest since last November (CNY7.1475) and today's was a little higher at CNY7.1491. A lower midrate means and lower dollar cap that is also a higher floor for the yuan. The dollar is consolidating in the recent range--CNH7.15-CNH7.19. Neither the larger trade surplus nor the stronger credit expansion pushed the dollar out of the pre-weekend trading range against the offshore yuan (~CNH7.1675-CNH7.1760). Helped by a recovery in exports to the US following the trade thaw, Chinese exports rose 5.8% year-over-year (4.8% May). Imports rose 1.1% (-3.4% May). The trade surplus was nearly $114.8 bln. Exports to the US are down 16% year-over-year and were off 34% year-over-year in May and 21% in April. Aggregate financing accelerated slightly to CNY22.83 trillion (year-to-date) to stand around 26% above a year ago, slightly greater than May. 

JPY: The dollar enjoys strong momentum against the yen and posted its highest settlement in nearly two months ahead of the weekend and a few ticks more today to reach almost JPY147.60. It is approaching the tentative trendline connecting the May and June highs (~JPY147.80). Above there is the June high itself slightly above JPY148.00. The fraying of the upper Bollinger Band (~JPY147.60) suggests proceeding with caution. To the extent the rates are an important driver of the exchange rate, the market appears to have priced in a firm US CPI report. It seems like when a buy-the-rumor, sell-the-fact drama often unfolds. After plummeting 9.1% in April, private sector core machinery orders (excluding shipbuilding and utilities), they fell another 0.6% in May, according to data reported earlier today. It is as if orders jumped in March (13%) and are returning to status quo ante. The industrial side of the economy seems to lack much forward momentum. The final May industrial production figures slipped by 0.1% rather than rise 0.5% as the preliminary report suggested. On the other hand, the tertiary activities index rose 0.6% in June after a 0.5% gain in May (initially 0.3%), suggesting services are   The Tokyo CPI points to a softer national figure due at the end of the week. Meanwhile, Japanese long-dated bonds lurched lower. The 30-year JGB yield rose 10 bp and is approaching the May high near 3.20%. The 40-year JGB yield rose about eight basis points to ~3.43%. The May high was closer to 3.70%. 

GBP: The disappointing May GDP saw sterling punch through the $1.3530 lows that corresponded to the (61.8%) retracement of the sterling's rally from the June 23 low. Sterling has fallen for six consecutive sessions coming into today and the five-day moving average has crossed below the 20-day. moving average. Its losses were extended to almost $1.3450 today. It has not been able to resurface above $1.3500 since the low was recorded. The highlight of the week lies ahead. The June CPI is due Wednesday followed by the labor market report on Thursday.

CAD: The stronger than expected June jobs data helped the Canadian dollar recoup the initial losses inflicted on the US 35% tariff threat. The Canadian dollar lost a net of about 0.20% on Friday, a middling performer within the G10. Still, the greenback appears to have forged a base in the CAD1.3640-60 area. It is recording an inside day and has been confined to a CAD1.33675-CAD1.3720 range so far today. The TSX fared better than most major bourses ahead of the weekend, slipping by about 0.30%. However, the 10-year yield rose to 3.50%, a six-month high. Canada report June CPI tomorrow, the data highlight of the week. The base effect warns of upside risks. In June 2024, prices fell by 0.1%. While the headline was below 2% in May (1.7%), the underlying core measures were elevated at 3%. Going into the report, the market is having second thoughts about a cut another cut this year. The odds of a September cut were further downgraded last week to 40% from around 80% in late June. The swaps market implies a year-end rate of a little more than 2.50%, the highest since February. 

AUD: The Australian dollar stalled after setting a marginal new high for the year (~$0.6595). After a flurry of activity in early Asia-Pacific trading on Friday, the Aussie chopped around in a fifth of a cent trading range (~$0.6560-$0.6580). It slipped to about $0.6555 today before steadying. Establishing a foothold above $0.6600 leaves little on the charts ahead of $0.6700. Despite being fooled last week by the RBA's decision to stand pat, the futures market pricing is 90%+ chance of a cut next month. Another cut in Q4 is fully discounted. 

MXN: The peso remains resilient. It reached its best level since last August in the middle of last week near MXN18.5525. It managed to absorb the shock of 50% tariff on Brazil and a 35% tariff on Canada without breaking. In fact, the dollar's high last week was set Monday a little above MXN. Over the weekend, the US indicated purchases of Mexico's goods, ostensibly not meeting the domestic content rules of the USMCA, will be subject to a 30% tariff on August 1 unless a new deal is struck. The peso has largely shrugged it off and the dollar remains within the pre-weekend range, trading between roughly MXN18.6550 and MXN18.7175 today. 

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