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Stephen Innes
Trade Conversation Remains High on the list of Supportive Factors.

While trade conversation remains high on the list of supportive factors for equity market this week, investors risk barometers are completely dialled in on the amplitude of the US Federal Reserve next easing cycle as the looser the policy, and the higher equity markets will soar. As is typical during the Fed Blackout period, investors usually shy away from front running policy decision which has been made even more complicated this week as questions are swirling if the ECB will hint at switching the QE tap back on.

The S&P 500 is straddling 3,000 points in anticipation of the Fed lowering interest rates, but if Fed guidance confirms they are easing for precautionary rather than recessionary reasons the market will easily extend on current gains while the looser the policy measure will dictate just how high equity markets take flight.

After a decade of unparalleled easy money policies, still, the global economy struggles with growth and absentee inflation. Lacking a more suitable contingency plan global central banks are set to engage in concerted policy easing yet again, with rate cuts all but inevitable in the US, China, and Europe. And asset purchases could be re-kindled in the Eurozone and other economies where interest rates are already at historic lows such as Japan, New Zealand and Australia. In the UK, Brexit is still the driving force, but rate cuts are highly likely, with a return to QE on a hard Brexit all but a lock.

Get ready for a deluge of central bank easing and lower interest rates forever.

Oil Markets

After an inanimate start to the New York session, oil market gradually climbed the price ladder on improved risk sentiment after reports of a planned trade meeting between the US and China and word from U.S. Central Command which said the United States might have taken down a second Iranian drone. Both events triggered a sizable short-covering rally after the markets have been struggling under the weight of a trade war-induced global consumption slump.

And for good measure, oil prices moved even higher after the American Petroleum Institute reported a substantial crude oil inventory draw of 10.961 million barrels for the week ending July 18, compared to analyst expectations of a much smaller yet still heavy -4 million barrels draw.

Indeed, oil markets were in desperate need of good news as with Libya lifting it “force majeure” and traders growing more price benevolent to middle east tension, investors will rejoice in this significant fundamental fillip although the Strom Barry inventory overhang and indications of another gasoline build will likely curb to some degree the markets topside ambitions as traders will look to the more definitive EIA report later in the week.


Gold markets

Gold got a boost from rising no-deal Brexit probabilities, which also significantly increases the odds of QE on the continent. However, the rally gave way to improved US-China trade news flows and a high degree of investor caution knowing that substantial speculative length has built up above $1400 and that gold markets reaction function will be asymmetric to the Fed’s post rate cut messaging.

While gold investors will continue to rebalance positions ahead of the FOMC, likely keeping markets in current ranges, but with QE apparently back on several central bank’s roundtable discussions, even the hint of non-conventional easing should continue to provide a solid footing for Gold prices to springboard if the Fed affirms the markets dovish suspicions.

ECB and the Euro

The market continues to swing between 4 and 6 basis points of cuts into today’s ECB rate decision, which has caused many to chase the EURUSD market lower Traders had expected ECB today’s rate cut probability to lessen into the meeting although price action last week was telling us that traders wanted to be short Euro into the meeting but not quite this short. However, the weak EU economic pulse and a higher probability of no-deal Brexit, traders are mindful that Draghi could unleash both a precautionary and recessionary policy bazooka of sorts.

Traders expect the Euro to continue to fall under the weight on negative-yielding bonds while nothing entirely new here; it will ensure EURUSD rallies are capped which has likely emboldened some pre-ECB short Euro position-taking.

While a rate cut today is bearish for the Euro in its own right, but the cut will increase the odds for an imminent QE significantly, and this is what could drive the Euro significantly lower.

Brexit and the Pound

The Pound continues to labour as Prime Minister Johnson makes a no-deal threat that much more credible suggesting Sterling isn’t about to escape the Brexit pressure cooker anytime soon. No-deal Brexit probabilities will nudge above 50 % in the weeks while the calls for an early election have already moved above that level. Indeed there is an active “Boris offer” to the Pound as no-deal Brexit uncertainty is causing investors a high level of angst especially with political and monetary policy uncertainty at the extreme levels when it comes to the UK.

Brexit supporter and UK economist Gerald Lyons is the front-runner with the bookmakers to become the next governor of the Bank of England. Lyons is a former advisor to Johnson, has spoken in support of Brexit, believes the UK government has room to borrow (as does Johnson) and thinks the 2% inflation target must remain.

But lending a modicum of support for the plundered Pound overnight, Bank of England Chief Economist Haldane says he would be very cautious about considering cutting rates barring some sharp economic slowdown. He says that despite Brexit the underlying pace of UK growth is a fraction below “cruising altitude”, and that as best the BoE can tell there is little slack in the UK economy. He says the market path of interest rates is not an accurate reflection of the most likely route of rates.

The Ringgit

The USDMYR is trading near our weekly top side range as the USD has been stronger than expected. However, most of the weakness was playing out against the Euro and Pound on a combination of easy ECB policy and increased no Brexit Fears.

But ECB easing is not detrimental for “carry- trade” and reach-for-return opportunities which will come on the back of accommodative central bank policy, which is not necessarily negative for Asia EM FX

With oil prices stabilising well off recent lows and the US and China preparing for face to face discussion the Ringgit hasn’t really fallen out of favour but instead is falling prey to broader USD rebalancing acts ahead of two key central bank events this month, ECB and FOMC.

This article was written by Stephen Innes, Managing Partner at Vanguard Markets LLC
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