27 July 2018
Trump’s secret: What would count as a ‘win’ for him?

By reconciling with the EU, President Trump has taken everybody by surprise. The real surprise isn't so much his sudden friendliness, but the small price the EU has had to pay for it

Blowing hot and cold

Few people expected reconciliation with the European Union as the outcome of European Commission President Jean-Claude Juncker’s visit to the Oval Office after the accusations and threats from President Trump in the weeks running up to the meeting. But how can it be that Trump switches from qualifying the EU as a “foe” to a beloved friend so quickly? The answer is simply that blowing hot and cold is part of his negotiation strategy. His accusations and especially his threats to impose tariffs scare US trade partners and make them willing to come to the negotiating table with concessions. 

With the threat of tariffs on steel and aluminium, Trump has already succeeded in getting concessions from South Korea, Brazil and Argentina. But with the EU, this strategy wasn't really working until the Trump-Juncker summit. The EU took the principled stand that trade talks weren't possible as long as the US maintained higher tariffs on steel and aluminium. This stance was stressed especially by the French, but Germany, who is more dependent on US demand, steered Juncker towards a more pragmatic approach aiming to avoid any further escalation of the tariff war. 

America booms: A strong GDP report across the board

The US economy expanded at an annualised rate of 4.1% in 2Q18. With inflation on the rise and the jobs market looking strong the Fed may have to strike a bolder tone at next week's FOMC meeting

Breaking down the numbers

US second-quarter GDP growth has come in at 4.1% annualised, broadly in line with expectations, while Q1 was revised up from 2% to 2.2%. The report is incredibly strong throughout. Consumer spending rose 4%, government spending was up 2.1% and non-residential investment was up 7.3%. Exports surged 9.3% and imports barely changed meaning net trade contributed 1.1 percentage points to the headline growth rate.

The only weakness was in residential investment which fell 1.1% after a 3.4% drop in Q1 while inventories subtracted 1% from headline growth. These developments are actually very supportive for 3Q18 growth – inventories will be rebuilt after such a sharp run down, while the strength in housing demand means a rebound in residential construction is only a matter of time away.

ECB: Get back to the cold drinks, nothing to see here

ECB leaves everything unchanged and confirms main messages from June

OK, given the summer heat, we will not even try and pretend that today’s ECB meeting was exciting. In fact, hardly anyone would have noticed if the ECB’s communication staff had simply replayed the tape from the June meeting on the live stream channel. As expected, the ECB and ECB President Mario Draghi chose to play extremely safe and did not deviate at all from the main messages from the June meeting: i) the ECB remains confident and determined to gradually end quantitative easing by the end of the year and ii) the first rate hike is still a long way out.

The ECB’s entire assessment of the eurozone economy was almost a verbatim copy from the one at the June meeting. The ECB continues to see a strengthening of the eurozone recovery, pointing to stabilised growth data, and at the same time shows strong confidence in a further pick-up in underlying inflationary pressure, stressing that uncertainty on the inflation outlook had receded. In short, the basis for the ECB’s policy message from June remains intact.

There was a little chance that Draghi could clarify the ECB’s definition of “through the summer of 2019” as there had been some speculation in markets on where the ECB would see the end of the summer, hence when there would be the first theoretical opportunity for a rate hike. Here, Draghi dodged the question, which in our view means that a first rate hike is still so far away for the ECB that it feels comfortable with some uncertainty in markets. Mainly for the German audience, Draghi also addressed the Target 2 imbalances, clearly downplaying the issue.

All of this means that our ECB calls remain unchanged. Even though the ECB has stressed the optionality of the anticipated gradual dovish tapering, we still think that it would need a severe slowdown of the recovery and/or continued low core inflation for the ECB not to stop QE by the end of the year. QE remains part of the toolbox but most ECB members would clearly be happy if it returns into the box and stays there, so that interest rates return as the ECB’s main policy instrument. In this regard, the ECB could eventually show more leniency than markets currently expect and postpone a first rate hike even further into the future, if need be. For the time being, however, we still think that Draghi does not want to go into the history books as the central bank president who never hiked interest rates. He will have two opportunities after the summer of 2019. As this is still a long way out, it is clear that the only intention of today’s meeting was to have a quiet summer this year.

Mid-year gold outlook: Timing the dollar

The US dollar rally has knocked gold into a substantially lower trading range with funds shorting the market in record numbers. Those shorts stand a good chance of being covered in 3Q but we ultimately pin a recovery in gold prices on whether the dollar reverses in 4Q

Taming the greenback

Gold has traded foremost as a currency through 2018, feeling the pressure from the dollar rally and in relative ignorance of the alternative drivers including geopolitical tensions, equity volatility and even yields. Charting the 60-day correlation visibly demonstrates that gold has had its longest and deepest negative inverse relationship with the US dollar index since 2005. Meanwhile, correlations with yields and equities have let up considerably since the tail end of 2017. Recently, gold has shown some signs that it could free itself from this deep relationship, with the 60-day correlation almost halving from nearly 80% to 40%. We think that's just a blip though and expect the dollar to drive gold through 4Q, at least.

If gold remains deeply connected to moves in the dollar as per our base FX forecast, gold prices ought to now be finding a floor and start improving into the next quarter.

President Trump's criticism of China and the EU for manipulating their exchange rates and the Federal Reserve for hiking interest rates is expected to stem the dollar rally. The rhetoric reflects the administration’s desire for a weaker dollar and we expect flows into the greenback to settle down. But our FX strategists think we’re unlikely to see those fresh longs bail out until Trump's hard-line on trade dissipates. ING economists think that will happen sometime in the fourth quarter after the November mid-term elections.

The relative EU-US outlook, meanwhile, is expected to narrow on the back of political stability in Italy and Germany amongst other factors. Our currency base case (EUR/USD at 1.23 by year end) then sees gold edging back closer to the $1300’s and we forecast an average of $1290/oz for 4Q.

How a ‘no deal’ Brexit could be avoided

Avoiding a ‘no deal’ boils down to finding a compromise on the Irish border solution. That will be far from easy – but the alternatives aren't really what supporters of a ‘hard Brexit’ want. A fudge might be possible after all

Why talk of “no deal” is increasing

Just two weeks ago, it seemed as if Prime Minister Theresa May had finally managed to craft a Brexit proposal that could unite her Cabinet.

But after her Chequer's away day, a string of ministers resigned in protest at the agreed plan. May was also forced to make several concessions to win the support for a piece of customs legislation from a sizable Brexiteer-faction of the Conservative Party known as the European Research Group (ERG), potentially complicating the implementation of her Brexit plan. Then, the next day, she came very close to losing a vote on future membership of a customs union, after a handful of pro-EU Conservative MPs rebelled against the government.

What’s becoming increasingly clear is that whatever direction the Prime Minister ultimately decides, she cannot count on a majority of MPs backing it. With no obvious way out of the current impasse, many are now asking: is it inevitable that the UK crashes out of the EU without a deal?

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In case you missed it: From ‘foe’ to friend?

The economic news this week broadly confirmed what we already knew; that the US is booming and the European Central Bank has no plans to raise interest rates before next summer. But there was one surprise and it's got investors excited. President Trump's trans-Atlantic truce on trade helped to calm fears of an all-out tariff war. But can we really relax? 

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